Accounting rate of return

Accounting rate of return

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  Accounting Rate ofReturn (ARR) Dr Indukoori S S N Raju
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  Accounting Rate ofReturn (ARR)  It is the simple tool to make a capital budgeting decision.  It considers the net income and book value of investments for the life of the project as stated in financial statements.  It doesn’t consider time value of money.  It is also known as  Average rate of return (ARR)  Accounting average rate of return (AARR) Dr Indukoori S S N Raju 2
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  Types of ARR ARR on Asset Value Calculates Return on Assets (ROA)  ARR on Capital Invested Calculates Return on Capital Employed (ROCE) Dr Indukoori S S N Raju 3
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  ARR on AssetValue  Profits after expenses is PAT which includes depreciation, interest and Tax.  IF PAT is not given, calculate PAT from EBDIT by deducting all items.  Book value is based on depreciation methods.  Closing value is the scrap value or net depreciated value. Dr Indukoori S S N Raju 4 100 * s investment Average return Average ARR  Period Project PATs all of Summation Return Average  2 Value Closing Value Starting Investment Average   It is return on assets ( ROA)
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  ARR – Problem1 Dr Indukoori S S N Raju 5 A new project is expected to give Rs 2.33 cr of cash flows every year for 10 years with an investment of Rs 10 Cr. Find its ARR.
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  0 1 510 Dr Indukoori S S N Raju 6 8 9 4 2 7 3 6 Rs -10 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 2. 33 Cr Rs 0 Q. A new project is expected to give Rs 2.33 cr of cash flows every year for 10 years with an investment of Rs 10 Cr. Find its ARR. ARR on Asset Value - Problem 1 Solution 46.6% 100 * Cr 5 Rs 2.33 Rs ARR    Average returns calculation not required as they are same for all years. 100 * s investment Average return Average ARR  Cr Rs5 2 0 Cr 10 Rs Investment Average   
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  ARR on AssetValue - Problem 2 Dr Indukoori S S N Raju 7 An electronic gadgets manufacturing company is contemplating to invest Rs 100 Cr in its expansion project to meet the demand in the coming 5 years. Its incremental income for this period is Rs 35 Cr every year. Calculate ARR with a straight line depreciation.
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  0 1 5 DrIndukoori S S N Raju 8 4 2 3 Rs 35Cr An electronic gadgets manufacturing company is contemplating to invest Rs 100 Cr in its expansion project to meet the demand in the coming 5 years. Its incremental income for this period is Rs 35 Cr every year. Calculate ARR with a straight line depreciation. ARR on Asset Value - Problem 2 Solution 46.6% 100 * Cr 50 Rs Cr 35 Rs ARR   Average returns calculation not required as they are same for all years 100 * s investment Average return Average ARR  Rs -100 Cr Rs 35Cr Rs 35Cr Rs 35Cr Rs 35Cr Cr Rs50 2 0 Cr 100 Rs Investment Average   
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  ARR on AssetValue - Problem 3 Dr Indukoori S S N Raju 9 An automobile ancillary unit has a new investment opportunity with a capital requirement of Rs 50 Crores with an annual PBDIT of Rs 10 Crores with 10% growth every year. Ints interest burde and tax rates are Rs 50 Lakhs and 30% respectively. Find out ARR on this project which has an annual asset depreciation of 10% and 5 years project life.
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  ARR on AssetValue - Problem 3 Solution Dr Indukoori S S N Raju 10 An automobile ancillary unit has a new investment opportunity with a capital requirement of Rs 50 Crores with an annual PBDIT of Rs 10 Crores with 10% growth every year. Ints interest burde and tax rates are Rs 50 Lakhs and 30% respectively. Find out ARR on this project which has an annual asset depreciation of 10% and 5 years project life. • Find out annual gross profit or PBDIT for every year with growth @ 10% on previous year. • Find out PAT or Net Income by deducting Depreciation, Interest and Tax Payment @ 30% on PBT • Find out depreciation every year @10% on initial value • Find out closing value or book value of assets after 5 years
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  ARR on AssetValue - Problem 3 Solution Dr Indukoori S S N Raju 11 5 4 3 Rs 10.00 Cr Rs 11.00 Cr Rs 12.10 Cr Rs 13.31 Cr Rs 14.64 Cr PBDIT PBIT Rs 5.00 Cr PBT Rs 4.50 Cr Rs 3.85 Cr Rs 4.62 Cr Rs 5.46 Cr Rs 6.39 Cr PAT Rs 3.15 Cr Rs 6.00 Cr Rs 7.1 Cr Rs 8.31 Cr Rs 9.64 Cr (Depreciation) (Rs 5.00 Cr) (Rs 5.00 Cr) (Rs 5.00 Cr) (Rs 5.00 Cr) (Rs 5.00 Cr) (Interest) (Rs 0.50 Cr) (Rs 0.50 Cr) (Rs 0.50 Cr) (Rs 0.50 Cr) (Rs 0.50 Cr) (Tax) (Rs 1.35 Cr) Rs 9.14 Cr Rs 7.81 Cr Rs 6.6 Cr Rs 5.50 Cr (Rs 1.35 Cr) (Rs 2.34 Cr) (Rs 1.98 Cr) (Rs 1.65 Cr) 0 1 2 - Rs 50 Cr Rs 3.15 Cr Rs 3.85 Cr Rs 4.62 Cr Rs 5.46 Cr Rs 6.39 Cr
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  ARR on AssetValue - Problem 3 Solution Dr Indukoori S S N Raju 12 • Deductions from PBDIT for 5 years to arrive at PAT Year EBDIT In Rs Cr Depreciation in Rs Cr Interest In Rs Cr Tax @ 30% PAT In Rs Cr 1 10.00 5 0.50 1.35 3.15 2 11.00 5 0.50 1.65 3.85 3 12.10 5 0.50 1.98 4.62 4 13.31 5 0.50 2.34 5.46 5 14.64 5 0.50 2.74 6.39 Total 25 23.47 Cr Rs Cr Rs 5 . 37 2 0 25 Cr 50 Rs Investment Average    Cr Rs 694 . 4 5 Cr 23.47 Rs Return Average   % 5 . 12 100 * 37.5 Rs Cr 4.69 Rs ARR  
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  ARR on CapitalInvested  Calculation is similar to ARR on Asset Value, but considers total capital invested instead of average book value of assets.  Total capital invested at the beginning of the project period is considered. Dr Indukoori S S N Raju 13 100 * Invested Capital Total PAT Average ARR  Period Project Inflows cash all of Summation PAT Average  It is the return on capital employed (ROCE) or invested (ROCI)
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  Views on ARR Advantages Simple measure.  Easy access to information. Disadvantages  Can be applied for situations to take decisions at prima facie situations but not for real time decisions.  The value is from accounting or financial statements but not market Value.  ARR can be manipulated by changing the depreciation methods.  It is misleading when two projects of different size are compared using ARR. Dr Indukoori S S N Raju 14
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  Dr Indukoori SS N Raju 15 Thank You