Average Rate of Return (ARR) (DP IB Business Management): Revision Note
Average rate of return (ARR)
The Average Rate of Return compares the average profit per year generated by an investment with the value of the initial capital cost
The average rate of return is calculated using the formula and is expressed as a percentage
This makes it easy to compare different investment options
Worked Example
Creative Frames, a small artwork framing business based in Bermuda, is considering an investment of $40,000 in new machinery. Megan, the business owner, believes that total returns over a 6-year period will be $76,000
Calculate the Average Rate of Return of the proposed investment. [4 marks]
Answer:
Step 1 - Deduct the capital cost from the total returns
$76,000 - $40,000 = $36,000 [1 mark]
Step 2 - Divide the outcome by the number of years of use
$36,000 ÷ 6 years = $6,000 [1 mark]
Step 3 - Substitute the values into the formula
[1 mark]
Step 4 - Multiply the outcome by 100 to find the percentage
0.15 x 100 = 15% [1 mark]
Evaluation of average rate of return (ARR)
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