Average Rate of Return

Average Rate of Return

The rate of return on an investment that is calculated by taking the total cash inflow over the life of the investment and dividing it by the number of years in the life of the investment. The average rate of return does not guarantee that the cash inflows are the same in a given year; it simply guarantees that the return averages out to the average rate of return.

ARR formula
The formula for ARR is:

ARR = average annual profit / average investment

Where,

Average investment = (book value at year 1+ book value at end of useful life) / 2

Average annual profit = total profit over investment period/number of years.

ARR – Example 1
XYZ Company is looking to invest in some new machinery to replace its current malfunctioning one. The new machine, which costs $420,000, would increase annual revenue by $200,000 and annual expenses by $50,000. The machine is estimated to have a useful life of 12 years and zero salvage value.

Calculate the depreciation expense per year: $420,000 / 12 = $35,000
Calculate the average annual profit: $200,000 – ($50,000 + $35,000) = $115,000
Use the formula: ARR = $115,000 / $420,000 = 27.4%
Therefore, this means that for every dollar invested, the investment will return a profit of about 27 cents.

Amit Kumar
Amit Kumarhttp:////hmhelp.in
Hii! Welcome to My digital home, I am Amit – an almost no-code generalist, helping businesses with their online presence using WordPress and other tools and simplifying some of their operations with ideas and automation. A psychology and philosophy geek by interest and a graduate in Hospitality Management. I founded hmhelp during college, which got me into WordPress. I am a highly motivated and results-oriented professional with a proven track record of success in the hospitality industry. I’m also a Digital Marketing Enthusiast with significant academic and practical experience managing digital content across multiple platforms. Skilled at SEO optimization, developing digital content for social media platforms, I offer extensive knowledge of multiple software programs, strong attention to detail, and extraordinary communication skills. If you are interested in talking about any of the topics I have mentioned on my website, you are in the right place. You can contact me or learn more about what I do. You can also connect with me on social networks.

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