Average Accounting Return Calculator

AAR Formula:

\[ AAR = \frac{\text{Average Net Income}}{\text{Average Investment}} \times 100 \]

AAR (%):

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1. What is Average Accounting Return (AAR)?

Average Accounting Return (AAR) is a financial ratio used in capital budgeting that measures the profitability of an investment by comparing average net income to average investment. It provides a simple percentage return based on accounting figures rather than cash flows.

2. How Does the Calculator Work?

The calculator uses the AAR formula:

\[ AAR = \frac{\text{Average Net Income}}{\text{Average Investment}} \times 100 \]

Where:

Average Net Income — The average annual net income generated by the investment
Average Investment — The average book value of the investment over its life

Explanation: The formula calculates the percentage return on an investment based on accounting income rather than cash flows, making it easy to compute using standard financial statements.

3. Importance of AAR Calculation

Details: AAR is useful for quick preliminary investment analysis and comparison with required rates of return. It's simple to calculate and understand, though it has limitations as it ignores the time value of money and uses accounting income rather than cash flows.

4. Using the Calculator

Tips: Enter average net income and average investment in dollars. Both values must be positive numbers, with average investment greater than zero.

5. Frequently Asked Questions (FAQ)

Q1: What is a good AAR percentage?
A: A good AAR depends on the industry and company standards. Generally, a higher AAR indicates better profitability, but it should be compared to the company's cost of capital and industry benchmarks.

Q2: How is AAR different from ROI?
A: While both measure profitability, AAR uses average values over the investment's life and accounting income, while ROI typically uses initial investment and may use cash flows or net income.

Q3: What are the main limitations of AAR?
A: AAR ignores the time value of money, uses accounting income instead of cash flows, and doesn't consider the project's entire life cycle cash flows.

Q4: When should AAR be used?
A: AAR is best used for quick preliminary screening of investment projects or when simpler analysis is preferred over more complex methods like NPV or IRR.

Q5: How is average investment calculated?
A: Average investment is typically calculated as (initial investment + salvage value) / 2, or as the average book value over the project's life.