Average Rate of Return

Average Rate of Return

The average rate of return also known as the unadjusted rate of return and the approximate rate of return is an accounting method and represents the ratio of the average annual profits after taxes to the average investment in the project (Van Horne). The average annual income is arrived at by adding all the earnings after depreciation (and taxes) and dividing them by the project.

economic life (x₁ + x_e +…….x_n/N) where xn is the net earning of the nth year and N is the economic life of the project in years). The average annual income when related to the investment, shall give the accounting or

                                                average rate of return,

                                                Thus, increase in

                                                Expected future average

                                                annual net income

Av. Rate of Return…………………………………………………..

Initial increase in required

Investment

Sometimes the denominator is the average investments rather than initial investment. Average investment in a project is the simple mean of the value of investment at the beginning and end of the useful life (the later is usually zero). Thus.

the average investment = Initial cost of investment/2

or half of the initial investment, Many authors would prefer the average investment, rather than initial cost of the project, for calculating the average rate of return, Thus, according to this approach :

Ax Rate of Return = Av. Annual income/Av. investment