Accounting Rate of Return Calculator

Calculate the average annual profit as a percentage of the investment

Investment Details

Initial Investment ($)

Salvage Value ($)

Project Life (years)

Annual Net Profits

Year 1 Profit ($)

Year 2 Profit ($)

Year 3 Profit ($)

Year 4 Profit ($)

Year 5 Profit ($)

ARR Results

Accounting Rate of Return

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%

Average annual return on investment

Average Annual Profit

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$

Mean annual net profit

Total Net Profit

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$

Sum of all annual profits

Annual Profit Breakdown

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Profit Summary

Year	Net Profit	Cumulative Profit	Return %

Investment Analysis

Decision Guide

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Benchmark Comparison

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This calculator provides estimates based on accounting profits. Consider other capital budgeting methods for comprehensive analysis. Print Results

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

The Accounting Rate of Return (ARR)—also called the Average Rate of Return (ARR)—measures the profitability of an investment based on accounting profits (not cash flows). It is expressed as a percentage and helps businesses evaluate capital budgeting decisions.

Key Features of ARR

✔ Uses net accounting profit (not cash flows).
✔ Simple to calculate (no discounting required).
✔ Helps compare projects based on average annual profitability.

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2. ARR Formula

The basic ARR formula is:

$$ARR=\frac{\text{Average Annual Profit}}{\text{Initial Investment}}\times 100\mathrm{\%}$$

Expanded Formula (if salvage value is considered):

$$ARR=\frac{\text{Average Annual Profit}}{\text{(Initial Investment + Salvage Value) / 2}}\times 100\mathrm{\%}$$

Where:

• Average Annual Profit = (Total Profit Over Life of Project) / (Project Life in Years)

• Initial Investment = Total upfront cost

• Salvage Value = Residual value at the end of the project

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3. How to Calculate ARR (Step-by-Step Example)

Example Scenario:

• Initial Investment: $100,000

• Project Life: 5 years

• Expected Annual Profits:

  • Year 1: $20,000

  • Year 2: $25,000

  • Year 3: $30,000

  • Year 4: $25,000

  • Year 5: $20,000

• Salvage Value: $10,000

Step 1: Calculate Total Profit Over 5 Years

$$20,000+25,000+30,000+25,000+20,000=\mathbf{\text{\$120,000}}$$

Step 2: Compute Average Annual Profit

$$\frac{120,000}{5}=\mathbf{\text{\$24,000}}$$

Step 3: Apply ARR Formula

Option 1 (Using Initial Investment Only)

$$ARR=\frac{24,000}{100,000}\times 100\mathrm{\%}=\mathbf{\text{24\%}}$$

Option 2 (Including Salvage Value)

$$\text{Average Investment}=\frac{100,000+10,000}{2}=\mathrm{\$}55,000$$$$ARR=\frac{24,000}{55,000}\times 100\mathrm{\%}\approx \mathbf{\text{43.6\%}}$$

(Note: Some companies use average investment instead of initial investment for a more conservative estimate.)

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4. How to Use an ARR Calculator

1. Enter Initial Investment → $100,000

2. Input Annual Profits → $20K, $25K, $30K, $25K, $20K

3. Add Salvage Value (if applicable) → $10,000

4. Select Calculation Method → Initial or Average Investment

5. Click "Calculate ARR" → Result: 24% or 43.6%

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5. Interpretation of ARR Results

ARR Value	Interpretation
ARR > Target Rate	Project is acceptable.
ARR < Target Rate	Reject the project.
Comparing Multiple Projects	Choose the one with the highest ARR.

Example Decision:

• Company’s Hurdle Rate = 20%

• Project ARR = 24% → ACCEPT

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6. Advantages of ARR

✅ Simple & Easy to Understand – Uses accounting data (no complex discounting).
✅ Quick Comparison – Helps rank multiple projects.
✅ Focuses on Profitability – Measures return on investment (ROI).

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7. Limitations of ARR

⚠ Ignores Time Value of Money (TVM) – Treats all profits equally (unlike NPV/IRR).
⚠ Uses Accounting Profits (Not Cash Flows) – May not reflect true liquidity.
⚠ No Clear Decision Rule – No universally accepted "good" ARR threshold.

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8. ARR vs. Other Investment Appraisal Methods

Method	Formula	Considers TVM?	Uses Cash Flows?
ARR	$\frac{\text{Avg. Profit}}{\text{Investment}}$	❌ No	❌ No (uses profit)
Payback Period	Time to recover investment	❌ No	✔ Yes
NPV	$\sum \frac{C{F}_t}{(1+r{)}^t}$	✔ Yes	✔ Yes
IRR	Discount rate where NPV=0	✔ Yes	✔ Yes

When to Use ARR?

• For quick profitability estimates.

• When cash flow data is unavailable.

• For internal performance comparisons.