ARR suffers from a major defect as a means of assessing investment opportunities.

Can you reason out what this is? Consider the three competing projects whose profits are shown below. All three involve investment in a machine that is expected to have no residual value at the end of the five years. Note that all of the projects have the same total operating profits after depreciation over the five years

(Hint: The defect is not concerned with the ability of the decision maker to forecast future events, though this too can be a problem. Try to remember the essential feature of investment decisions, which we identified at the beginning of this chapter.)

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Time Immediately 1 year's time 2 years' time 3 years' time 4 years' time 5 years' time Cost of machine Operating profit after depreciation Operating profit after depreciation Operating profit after depreciation Operating profit after depreciation Operating profit after depreciation Project A Project B Project C 000 000 000 (160) (160) (160) 20 10 160 40 10 10 60 10 10 60 10 10 20 20 160 10