Presentation

• Presented By
Neelam Abbas
• Presented To
Mr. Waqas Ahmad
Accounting Rate of Return & Internal
Rate of return
Accounting Rate of Return
Accounting rate of return, also known as the Average rate of
return or simple rate of return. The accounting rate of return is
used in capital budgeting to estimate whether to proceed with
an investment. The calculation is the accounting profit from the
project, divided by the initial investment in the project
Merits of ARR
• It is very simple to understand and use.
• This method takes into account saving over the entire This
method takes into account saving over the entire economic
life of the project. Therefore, it provides a better economic life
of the project.
• This method through the concept of "net earnings" ensures a
compensation of expected profitability of the projects and
• It can readily be calculated by using the accounting data.
Demerits of ARR
• It ignores time value of money.
• It does not consider the length of life of the projects
• It is not consistent with the firm's objective of maximizing the
market value of shares
• It ignores the fact that the profits earned can be reinvested
Formula of ARR
• Accounting Rate of Return is calculated using the following
formula:
Average Accounting Profit
ARR = _________________________
Average Investment
INTERNAL RATE OF RETURN
• The internal rate of return (IRR) is a metric used in capital
budgeting to estimate the profitability of potential
investments. The internal rate of return is a discount rate that
makes the net present value (NPV) of all cash flows from a
particular project equal to zero.
Formula of IRR
•  IRR calculations rely on the same formula as NPV does.

IRR=NPV = t = 1∑T(1+r) tCt − C0 = 0

• where:
• Ct = net cash inflow during the period t
• C0 = total initial investment costs
• R = the discount rate, and
• T = the number of time periods
Calculation of IRR
• Two situations

1) Even cash flows an

2) Uneven cash flows
Even (annuity) Cash flows
• Same amount is received as earnings
• Determine payback period(investment ÷ inflows)
• Determine the rate (%) for the value. It is the IRR .
IRR in Mixed stream (Uneven cash
flows)
• Trial and error method
1. Take an assumed interest rate
2. Determine the present value of inflows of each year. Use the
PV Table (Inflow X PV Factor)
3. Find the total of Present values of inflows
4. Compare it with the outflows
5. If both are the same and the difference is zero, the IRR (r) of
the project will be the assumed interest taken in the first step
6. If the PV of inflows > outflows, (NPV is positive) take a
higher ‘r’ than that of the first step and vice versa
7. Repeat the steps from two to five
8. Continue the process till NPV = 0
9. Sometimes the IRR may lie in between two rates (say 12%
and 14%), then the exact rate is to be determined by
interpolation