Before proceeding further, make sure that you understand fully the calculation and usefulness of the accounting rate of return. Check also that you understand the limitations of relying on the accounting rate of return when evaluating a project.

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Calculations for the accounting rate of return Cash flows Outlay (a) Profits, after deducting depreciation from cash flows Year 1 Year 2 Year 3 Average annual profit (b) Accounting rate of return (b x 100/a) Project A 120,000 20,000 20,000 20,000 20,000 16.7% Project B 120,000 5,000 5,000 5,000 5,000 4.2% Project C 120,000 nil 30,000 40,000 23,000 19.2%