Advantages and disadvantages of accounting rate of return, Financial Management

Advantages of ARR:

  • It is simple to calculate and easy to catch.
  • With the help of this technique, direct comparisons among proposed projected of varying lives with no built-in-prejudice in favor of short-term ventures can be made.

Disadvantages of ARR :

  • This technique ignores time value of money.
  • It fails to shed light on yearly rate of return of the project. It may be possible for the project producing higher earnings in the early years to show a lower average rate of return and be rejected in support of other projects.
  • Serious errors can happen in selection of projects if corporate managers

Accept projects whose accounting rates are equivalent to the or above some arbitrarily selected cut-off rate, and they reject projects whose accounting rates fall short of the cut-off rate.

  • Accounting information is not appropriate for investment decision because it fails to differentiate between cash flowing in and out of the company and book keeping transactions.
  • There is no full agreement on the exact measure of the term investment.

Therefore, different managers have different meanings when they refer to ARR.

Posted Date: 10/15/2012 9:14:50 AM | Location : United States

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