Accounting Rate of Return (ARR) is a formula used to calculate the net income expected from an investment or asset compared to the initial cost of investment. Typically, ARR is used to make capital budgeting decisions.
The accounting rate of return (ARR) is a way of comparing the profits you expect to make from an investment to the amount you need to invest. The ARR is normally calculated as the average annual profit you expect over the life of an investment project, compared with the average amount of capital invested.
1. First, figure out the cost of a project that is the initial investment required for the project.
2. Now find out the annual revenue expected from the project, and if it is comparing from the existing option, then find out the incremental revenu...
3. There shall be annual expenses or incremental expenses compared with the existing option. All should be listed.
4. Now, for each year, deduct the total revenue less total expenses for that year.
5. Divide your annual profit arrived in step 4 by the number of years the project is expected to stay or the life of the project.
6. Finally, divide the figure arrived in step 5 by the initial investment, and resultant would be an annual accounting rate of return for that proj...
Rate of return pricing or Target-return pricing is a method of which a firm will set the price of its product based on their desired returns on said product.
The concept of rate return pricing is very similar to return on investment however, in this circumstance the company can manipulate its prices to achieve the desired goal.
This method is used primarily by companies that either have a lot of capital or have a monopoly on the market and when an investor requests a specific return on their investment.
In a competitive market rate of return pricing can be a poor market strategy as its focus at the final profit margins and does not account for supply and demand factors.
If a competitor is able to set a lower price, it could decrease demand for the product resulting in a lower sales then forecasted and failing to reach the desired profit margin.