As you can see, the Accounting Rate of Return is quite a simple formula which is computed by dividing the average profit by the amount of the total funds employed in the project. The profit thereby refers to the pre-tax operating profit while the average amount of total funds employed is based on the book value of the assets invested and includes incremental net fixed assets plus or minus related working capital. Moreover, in the case of the Super Project, start-up costs and any profits or losses incurred before the project became operational are included in the first profit and loss period in financial evaluations.
Thus the first advantage of this investment measure is constituted by its ease of calculation and hence providing a quick estimate of a project's worth over its useful life. It simultaneously enables the comparison of different projects.
The major drawbacks of ARR are that it uses profit rather than cash flows, and it does not account for the time value of money. Therefore, though cash flows are more important to investors, the ARR is based on numbers that include non cash items. Subsequently, by contrast to the NPV and IRR methods explained later these cash flows do not diminish with time. Like this it doesn’t adjust for the greater risk to longer term forecasts. Otherwise, there have been developed more sophisticated alternatives which are not significantly more difficult to calculate. Due to the problems mentioned any method of selecting investments based on it is necessarily seriously flawed.
The calculated value of 72.58% in the case of Super clearly indicates a good investment and also exceeds the hurdle of 40% given by General Foods general evaluation criteria....