Finance Numericals

Accounting Rate of Return (ARR): It measures average return on investment in terms of income rather than cash flows.It is also known as return on investment or return on capital employed . Higher the ARR of a project better for the investment. It does not consider time value of money. Advantages of Accounting Rate of Return: ·         It is very simple and easy to calculate. ·         It needs financial statement for computing ARR. ·         It gives rough idea to know that is this investment is good for business or not?. Company cannot depend on ARR for taking a decision. Disadvantages of Accounting Rate of Return: ·         It does not include time value of money concept. ·         It does not show accurate value of investment because it is just based on averages of cash flows. Formula for Accounting Rate of Return (ARR): Accounting Rate of Return (ARR) = Average net annual income/ Average Investment                                                 

Payback Period:  It is a tool of capital budgeting which helps to determine, how many periods are required to payout the investment amount to investors or company? With the help of it we can find out which investment is better to fulfil our requirement. Lesser the payback period better will be the investment. The drawback of payback period is, it does not consider time value of money so, to remove that drawback discounted payback period is used. Advantages of Payback period: o    It is very simple to compute. o    It is easy to understand. o    It helps in ranking the investment projects. Disadvantages of Payback period: o    It ignores time value of money which means it does not show the future retun is how much worth today?. o    It doesn’t consider the cash flows which occur after the intial investment amount has been received. Formula for Payback Period: Payback Period = Cost of Initial Investment/ Net Annual Cash flows Example:   Suppose initial