Foundations Of Senior Management

Finance
Investment appraisal

Non-DCF

Accounting rate of return (ARR)

  Year 1

(£)

 Year 2

(£)

 Year 3

(£)

 Year 4

(£)

 Year 5

(£)

 Year 6

(£)

 Average

(£)

Accounting profit -16,667 93,333 53,333 13,333 -26,667 -46,667 11,666
Average capital employed 366,667 300,000 233,333 166,667 100,000 33,333 200,000
Annual ARR -4.55% 31.11% 22.86% 8.00% -26.67% -140%  
Average ARR             5.83%

  • Average ARR over project life
     
  • Annual ARR during project life
     
  • Disadvantages
     
    • Complicated
       
      • Accurate predictions required
         
    • Uses arbitrary non-cash items
       
      • e.g Depreciation
         
      • Accruals
         
      • Provisions
         
    • Percentage method
       
      • relative not absolute
         
    • Ignores the time value of money
       

Payback period

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Net cash flow -400 50 160 120 80 40

Cumulative cash flow -400 -350 -190 -70 10 50

Payback

  • Advantages
     
    • Simplicity
       
  • Disadvantages
     
    • Ignores all cash flows after payback period
       
    • Does not take into account the riskiness of the investment
       
    • Does not take into account the time value of money
       

Please send your comments to webmaster@churcher.com. This document was updated 17/11/98.