Wednesday, February 4, 2015

Average rate of return method


Accounting or Average rate of return means the average yield on the project. Under this method profit after tax & depreciation as % of total investment is considered.
Suppose a project needs an investment of Rs. 20,00,000 & profit after tax & depreciation are as follow:

Years                                              Profit after tax & depreciation
1.                                                             1,00,000  
2.                                                             1,50,000
3.                                                             2,50,000
4.                                                            2,60,000
5.                                                            1,60,000
                                                ------------------------
       Total                                            9,20,000
                                                ------------------------
And suppose that at the end of the year 5th, the plant & machinery of the project can be sold for Rs. 1,60,000. In this case the rate of return can be calculated as follows:
                                                               Total profits * 100
            ---------------------------------------------------------------------------------------------------
                                Net investments in the project     *  No. of years of profits

i.e                                  Rs. 9,20,000
                          --------------------------------------  *  100         =      10%
                                 Rs. 18,40,000  *  5 years

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