Learning objective
Calculate average rate of return for business investment projects.
Read the explanation, check the common trap, then practise with flashcards and questions.
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Topic
Financial terms and calculations
Subtopic
Average rate of return
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Quick explanation
Calculate average rate of return for business investment projects
- This point belongs to Financial terms and calculations, especially Average rate of return.
- You need to be able to calculate average rate of return for business investment projects.
- The key ideas to know are investment and average rate of return.
- Use the linked flashcards and practice questions to check recall, then practise applying the idea in an exam-style answer.
Key concepts
Why it matters
This objective helps connect Average rate of return to exam-style questions, flashcards, and revision notes for Financial terms and calculations.
Quick student answer
A small manufacturer invests £120,000 in new machinery. Over the next five years it earns a net profit of £30,000 each year. Calculate the average rate of return for this investment.
Direct answer
ARR = (Net profit ÷ Initial investment) × 100 = (£30,000 ÷ £120,000) × 100 = 0.25 × 100 = 25%
How it works
The net profit per year is £30,000. The initial investment is £120,000. Dividing gives 0.25, which is 25% when expressed as a percentage. This is the average rate of return over the five‑year period.
Key terms
- Average rate of return: The percentage of profit earned on an investment relative to the initial cost of that investment, calculated as (Net profit ÷ Initial investment) × 100.
Common trap
Confusing ARR with IRR: Remember that ARR uses net profit and initial investment only, while IRR involves discounting future cash flows to present value.
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Revision notestopic notes
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Open revision notesRelated learning objectives
- Distinguish variable costs, fixed costs and total costs.
Costs, revenue, profit and loss
- Explain revenue, costs, profit and loss.
Costs, revenue, profit and loss
- Explain investment projects such as investment in machinery, buildings and vehicles.
Average rate of return
- Explain break-even output.
Break-even
- Interpret break-even charts.
Break-even