Accounting Rate of Return (ARR) Calculator

Formula

Accounting Rate of Return (ARR): ARR = Average Accounting Profit ÷ Investment Base × 100. The investment base can be the initial outlay or the average book value over the asset’s life under straight-line depreciation: (Initial + Salvage) ÷ 2.

Detailed mode assumptions

• Straight-line depreciation: (Initial − Salvage) ÷ Life.
• Accounting profit ≈ (Revenue − Cash Expenses − Depreciation) × (1 − Tax Rate).
• No financing/interest effects are modeled.

Informational only — not financial advice. Double-check results before making decisions.

How to calculate ARR step by step

1. Find total accounting profit over the project life, after depreciation and other accounting costs.
2. Calculate average annual accounting profit by dividing total profit by the number of years.
3. Choose the investment base: initial investment or average book value.
4. Divide average annual profit by the investment base.
5. Multiply by 100 to express ARR as a percentage.

Initial investment vs average investment in ARR

ARR calculation examples

Example 1: ARR using initial investment

A project costs £50,000 and produces average annual accounting profit of £10,000.

ARR = £10,000 ÷ £50,000 × 100 = 20%

Example 2: ARR using average book value

A machine costs £60,000, has a salvage value of £20,000, and produces average annual accounting profit of £7,000.

Average book value = (£60,000 + £20,000) ÷ 2 = £40,000.

ARR = £7,000 ÷ £40,000 × 100 = 17.5%

Example 3: ARR with depreciation

If an asset costs £10,000, has no salvage value, lasts 5 years, and earns £3,000 before depreciation each year, annual depreciation is £10,000 ÷ 5 = £2,000.

Average accounting profit = £3,000 − £2,000 = £1,000. ARR using initial investment = £1,000 ÷ £10,000 × 100 = 10%.

How to interpret ARR

A higher ARR usually means a project generates more accounting profit for each pound invested. In capital budgeting, ARR is often compared with a target rate or hurdle rate.

• If ARR is above the target rate, the project may be acceptable.
• If ARR is below the target rate, the project may be rejected.
• If two projects have similar ARR, compare them with NPV, IRR, payback period, and risk.

What is Accounting Rate of Return (ARR)?

The Accounting Rate of Return (ARR) is a simple profitability metric used in capital budgeting. It expresses the average annual accounting profit from a project as a percentage of the investment base. Unlike cash-flow methods, ARR focuses on earnings reported in the income statement (after depreciation and typically after tax), making it easy to reconcile with financial statements and management reports.

ARR formulas used in this tool

Core formula: ARR = Average Accounting Profit ÷ Investment Base × 100. The investment base can be defined in different (but common) ways:

• Initial investment (cost of the asset or project outlay).
• Average book value, often approximated under straight-line depreciation as (Initial + Salvage) ÷ 2.
• Custom base when a specific policy or course requirement applies.

In Detailed mode, the tool derives profit with straight-line depreciation: Depreciation per year = (Initial − Salvage) ÷ Life. Profit after tax is approximated as (Revenue − Cash Operating Expenses − Depreciation) × (1 − Tax Rate). In Simple mode, you can input the average annual accounting profit directly (useful when you already have a forecast or policy figure).

Worked example

Suppose an asset costs £10,000, has no salvage value, and a useful life of 5 years. Annual revenue is £6,000; cash operating expenses are £2,500; tax rate is 25%. Straight-line depreciation is £2,000 per year. Profit after tax ≈ (6000 − 2500 − 2000) × 0.75 = 1,125. If you use the initial investment as the base, ARR ≈ 1,125 ÷ 10,000 = 11.25%. Using the average book value base (here £5,000), ARR ≈ 1,125 ÷ 5,000 = 22.5%. The choice of base materially changes the percentage, which is why policies differ.

Strengths and limitations

• Pros: Quick to compute, easy to explain to non-finance stakeholders, aligns with financial statement profit.
• Cons: Ignores cash-flow timing and risk; can vary based on denominator choice; not a discounting method.

When to use ARR vs. NPV/IRR

ARR is ideal for early screening, performance targets tied to accounting profit, or comparing projects within the same policy framework. For investment decisions where timing of cash flows matters (e.g., property, infrastructure, multi-year programmes), complement ARR with NPV (net present value) or IRR (internal rate of return).

This material is for education only and is not financial advice. Always check your organisation’s policy (e.g., whether to use initial or average investment and whether profits are pre- or post-tax).

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