1. What is the Average Rate of Return (ARR)?

The Average Rate of Return (ARR) is a financial metric used to measure the profitability of an investment. It calculates the average annual profit as a percentage of the average investment, providing a simple way to compare different investment opportunities.

2. How Does the Calculator Work?

The calculator uses the ARR formula:

Where:

• \( \text{Average Profit} \) — Average annual profit over the investment period ($)
• \( \text{Average Investment} \) — Average amount of capital invested ($)

Explanation: The formula expresses the return on investment as a percentage, making it easier to compare investments of different sizes and durations.

3. Importance of ARR Calculation

Details: ARR is crucial for investment appraisal, helping businesses evaluate the profitability of capital projects and make informed investment decisions. It's particularly useful for comparing projects with similar characteristics.

4. Using the Calculator

Tips: Enter the average annual profit and average investment amount in dollars. Both values must be positive numbers, with average investment greater than zero for valid calculation.

5. Frequently Asked Questions (FAQ)

Q1: What is a good ARR percentage?
A: A good ARR depends on the industry and risk level, but generally, ARR above 15-20% is considered good, while below 10% may be unsatisfactory.

Q2: How is average profit calculated?
A: Average profit is calculated by summing the net profits over the investment period and dividing by the number of years.

Q3: What are the limitations of ARR?
A: ARR ignores the time value of money, doesn't consider cash flow timing, and can be manipulated by changing depreciation methods.

Q4: How does ARR compare to other investment appraisal methods?
A: ARR is simpler than NPV and IRR but less sophisticated as it doesn't account for the time value of money or risk factors.

Q5: When should ARR be used?
A: ARR is best used for quick comparisons of similar projects or as a supplementary measure alongside more sophisticated methods like NPV and IRR.