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The document outlines the Accounting Rate of Return (ARR) method for evaluating an investment opportunity involving a machine costing Rs. 80,000 with a five-year life and a scrap value of Rs. 10,000. It provides calculations for total profit, depreciation, and ARR, resulting in an initial ARR of 10% and an average ARR of 17.78%. Additionally, it discusses the internal rate of return (IRR) for two projects, with Project A's IRR estimated between 10% and 12%.

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Vaishnavi khairnar
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29 views9 pages

Examples

The document outlines the Accounting Rate of Return (ARR) method for evaluating an investment opportunity involving a machine costing Rs. 80,000 with a five-year life and a scrap value of Rs. 10,000. It provides calculations for total profit, depreciation, and ARR, resulting in an initial ARR of 10% and an average ARR of 17.78%. Additionally, it discusses the internal rate of return (IRR) for two projects, with Project A's IRR estimated between 10% and 12%.

Uploaded by

Vaishnavi khairnar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd

Accounting Rate of Return Method:

Consider the following investment opportunity: A


machine is available for purchase at a cost of Rs.
80,[Link] expect it to have a life of five years and to
have a scrap value of Rs. 10,000 at the end of the Five
year period. We have estimated that it will generate
additional profits over its life as follows:

These estimates are of profits before depreciation. You are


required to calculate the return on capital employed
rtunity: A
ost of Rs.
ears and to
of the Five
ll generate

n. You are
yed
Solution

Total profit before depreciation over the life of the machine


= Average profit p.a. = Rs. 1,10,000 / 5 Years
Total Depreciation Over the life of the machine (Rs. 80,000 – R
10,000)
= Average depreciation p.a. = Rs. 70,000 / 5 Years

= Average annual profit after depreciation = Rs. 22,000 – Rs. 1


Original Investment required
= Accounting rate of return(initial) (ARR) = (Rs. 8,000 / Rs.
80,000)*100
Average Investment = (Rs. 80,0000+ Rs. 10,000) / 2
= Accounting rate of return (Average) (ARR) = (Rs. 8,000 / Rs
45,000) * 100
= Rs. 1,10,000
= Rs. 22,000
= Rs. 70,000
= Rs. 14,000

= Rs. 8,000
= Rs. 80,000
10%
= Rs. 45,000
17.78%
Example:
A company has to decide whether to undertake a proposed project:

Calculate the internal rate of return

Solution:
Let’s take in case of project A, the rate comes to 10%
while in case of project B it comes to 15%.

Project A:
Calculation of NPV at 10%
The internal rate of return is thus more than 10% but less than 12
P.V. Required 11,000
P.V. at 10% 11,272 (+272) Actual IRR ꓿10(+) 272
P.V. at 12% 10,844 (-156) 272-(-156)

Actual IRR ꓿ 11.27%


Project A:
Calculation of NPV at 12%

Cash Flow Discounting Present


Year (RS.) Factor at 12% value
1 6,000 0.893 5,358
2 2,000 0.797 1,594
3 1,000 0.712 712
4 5,000 0.636 3,180
Total Present Value 10,844

n 10% but less than 12%. The exact rate may be calculated

*2

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