How to solve for Average Accounting Rate of Return?

The AAR (Average Accounting Rate of Return) measures the average accounting profit earned on the average amount of capital invested over a project's life span for a company. Assets are normally depreciated on a straight-line basis with the method. Therefore the average book value formula is solved by dividing the initial investment by the length of the project's expected life:

Average book value of assets: $12,000,000/2 = $6,000,000

This assumes a beginning value of $12,000,000 and an ending value of $0. Hence, they have an average value of $6,000,000.

Next you must calculate average net income over the period:

($900,000+$1,350,000+$1,200,000+$1,950,000)/4 = $1,350,000

The Average Accounting Return (AAR) Equation is:

AAR= Average Net Income/Average Book Value

= $1,350,000/$6,000,000

= .225 or 22.5%

Using the Average Accounting Rate of Return (AAR) formula and equation is good capital budgeting tool because managers can compare it to objective benchmarks and past perfomance.

External Links:

Evaluating Business Investments

What is Residual Income?

What is Working Capital Management?