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    Advantages and Disadvantages of ARR and IRR

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    Please discuss:
    a) If a company used the Accounting Rate of Return to evaluate all the capital projects how do you account for one disadvantage in using this method in that this is not a rate of return, but a ratio of two accounting numbers. How do you account for the fact that this method ignores the time value of money?

    b) What are some of the disadvantages of just using the IRR method for evaluating a capital project?

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    Solution Preview

    a) The accounting rate of return is a return on investment. The income over the period is averaged and is divided by the average investment to get the Accounting rate of Return. This measure gives an idea of the rate of return based on the net income instead of cash flows. The Accounting rate of Return has a disadvantange that it ignores time value of money. The return is simple to calculate, managers are more versed with net income ...

    Solution Summary

    The solution explains the accounting rate of return and the IRR methods of capital budgeting.