accounting rate of return calculator

What is the accounting rate of return (ARR)?

The Accounting Rate of Return is a capital budgeting metric that measures how much accounting profit a project is expected to generate relative to the capital invested. Unlike cash-flow methods, ARR uses accounting income, which makes it easy to explain in management reports and budgeting meetings.

ARR is often used as a quick screening tool when teams compare several investment opportunities, such as buying equipment, launching a small product line, or upgrading operations.

Standard ARR formula

• Average annual accounting profit: annual profit after depreciation (and often after tax).
• Average investment: commonly calculated as (Initial investment + Salvage value) ÷ 2.

How to use this ARR calculator

Step-by-step inputs

• Enter the total initial investment required for the project.
• Add the expected salvage value at the end of the asset's useful life.
• Enter useful life in years to compute annual depreciation.
• Input expected annual revenue.
• Input annual operating costs excluding depreciation.
• Set your tax rate and your minimum acceptable target ARR.

Click Calculate ARR and the tool will show annual depreciation, annual accounting profit, average investment, ARR based on average investment, ARR based on initial investment, and a quick decision message.

Worked example

Suppose a company evaluates a machine with these assumptions:

• Initial investment: $100,000
• Salvage value: $10,000
• Useful life: 5 years
• Annual revenue: $55,000
• Annual operating costs (excluding depreciation): $22,000
• Tax rate: 25%

Calculation flow:

• Annual depreciation = (100,000 - 10,000) / 5 = $18,000
• Profit before tax = 55,000 - 22,000 - 18,000 = $15,000
• Tax = $15,000 × 25% = $3,750
• Annual accounting profit after tax = $11,250
• Average investment = (100,000 + 10,000) / 2 = $55,000
• ARR = 11,250 / 55,000 × 100 = 20.45%

How to interpret ARR results

ARR has meaning only when compared against a benchmark. Most firms define a required minimum ARR (a hurdle rate) based on risk, strategy, and alternative uses of capital.

• ARR above target: project may be acceptable from an accounting return perspective.
• ARR near target: consider sensitivity analysis and qualitative factors before deciding.
• ARR below target: project may not meet expected profitability standards.

Advantages and limitations of ARR

Advantages

• Simple to compute and communicate.
• Uses accounting numbers managers already track.
• Useful for quick ranking of smaller projects.

Limitations

• Ignores time value of money.
• Based on accounting profit, not actual cash flow.
• Can vary depending on depreciation policy.
• May conflict with NPV or IRR for long-term projects.

ARR vs NPV, IRR, and payback period

ARR is helpful, but it should not be your only decision metric. A stronger capital budgeting process often uses multiple methods:

• NPV (Net Present Value): best for value creation because it discounts future cash flows.
• IRR (Internal Rate of Return): gives the discount rate where NPV equals zero.
• Payback Period: shows how quickly initial investment is recovered.
• ARR: provides an accounting-profit lens that is fast and intuitive.

Common mistakes to avoid

• Including depreciation in operating costs and then subtracting it again.
• Using salvage value higher than initial investment.
• Comparing ARR across projects with very different risk profiles.
• Making final decisions using ARR alone without discounted cash flow analysis.

Frequently asked questions

Is a higher ARR always better?

Generally yes, but only if project risks, durations, and strategic fit are comparable.

Should ARR be calculated before tax or after tax?

Companies use both approaches. This calculator applies tax to provide an after-tax accounting profit view, which is often more realistic for decision-making.

Can ARR be negative?

Yes. If annual accounting profit is negative, ARR will be negative, signaling that the project is expected to reduce accounting earnings.

Use ARR as a practical first filter, then validate final investment decisions with NPV, IRR, and scenario analysis for a more complete financial picture.