Question

Which of the following is not an advantage of the average rate of return method?

a. It includes the amount of income earned over the entire life of the proposal.
b. It emphasizes accounting income.
c. It is easy to use.
d. It takes into consideration the time value of money. 

Answer 1

Concepts and reason

Average rate of return or Accounting rate of return method: Accounting rate of return (ARR) is calculated by dividing accounting profit of a project by the average investment made of project. ARR is used to evaluate the projects. It is one of the easiest method of project evaluation. It does not consider the present value or time value of money.

Fundamentals

The average rate of return is calculated using the following formula:

The average rate of return is calculated by dividing the average accounting profit with average investment.

Accounting rate of return is one of the methods of calculating the return on investment. The return on investment is calculated by using different methods, out of which the accounting rate of return is an easy method to use. There are many advantages but some constraints are also present in this method.

Following are the various advantages of accounting rate of return method:

It includes the amount of income earned over the entire life of the proposal.

It emphasizes accounting income.

It is easy to use.

Accounting rate of return is one of the methods of calculating the return on investment. It does not consider the time value of money. It is easy to use but doesn’t serve various purposes of calculating the rate of return on investment.

Ans:

The average rate of return method takes into consideration the time value of money is not an advantage.