Question

What are the differences (Atleast 3) between accounting rate of return and internal rate of return methods?

Answer 1

1. IRR uses Cashflow as a source of inflow or income while the ARR is using the Accounting Profit as the income.

2. IRR also consider the time value of money while ARR does not consider the time value of money

3. IRR is a discount rate at which Project's NPV is ZERO while the ARR is just simply Annual Rate pof return from the project which can be generated by dividing average profit by average investment

4.

Decision Criteria

Decision criteria are the evaluation parameters that influence the selection or rejection of capital investment opportunities. Whereas the decision criterion for IRR is based on the cost of capital, the decision criterion for ARR is set by the management. Management selects a project when its IRR exceeds the cost of capital and rejects it when the IRR is less than the cost of capital. For ARR, the management team selects an independent project as long as it exceeds the limits the team has set.