A level Business Revision - The ARR Method of Investment Appraisal

To calculate ARR, first, determine the total net returns of the project (e.g., £17 million for a £10 million investment over four years, resulting in £7 million profit). Then, divide this total profit by the project's life (e.g., £7 million / 4 years = £1.75 million) to get the average annual profit.

Once the average annual profit is calculated, divide it by the initial cost of the investment and multiply by 100 to get a percentage (e.g., £1.75 million / £10 million * 100 = 17.5%). This 17.5% represents the ARR.

Businesses can compare the ARR of different projects (e.g., 17.5% vs. 25% ARR) to choose the one with the highest return. It can also be compared to bank interest rates (e.g., 17.5% ARR versus 4% bank interest) to assess if the risk is worthwhile.

A key criticism of ARR is that it doesn't prioritize time, which can be an issue for cash-sensitive firms. It also doesn't account for the declining value of money over time due to inflation or the opportunity cost of having money sooner. This limitation is addressed by other methods like Net Present Value (NPV).

The ARR (Annual Rate of Return) method of investment appraisal calculates a percentage return an investment will give annually, helping businesses decide on potential projects. Unlike the payback method, ARR considers all net returns over a project's entire life.