Which statement best describes ARR (average rate of return)?

• A. a measure of cash flow timing
• B. a measure of return relative to initial cost
• C. a measure of market share
• D. a measure of accounting profit only

Answer: (B)

ARR expresses the return on an investment as a percentage of the amount invested, using average annual accounting profit. It converts profit into a rate by dividing the average yearly profit by the initial cost (or average investment) and multiplying to get a percentage. This makes ARR a simple profitability gauge tied to how much was spent, rather than focusing on when cash flows occur or on market position. It relies on accounting profit, not cash-flow timing, and it isn’t about market share. For example, if the project earns an average of £40,000 in accounting profit each year and the initial outlay is £160,000, ARR is 40,000/160,000 = 25%. That’s why the statement describing ARR as a measure of return relative to initial cost is the best answer.