Accounting rate of return revisited

Abstract

ABSTRACTFinancial theory advocates the use of discounted cash flow techniques for purposes of making investment dicisions. Techniques such as Accounting Rate of Return (ARR) are rejected for a variety of reasons. Shareholders, however, cannot know that a company is making positive net present value investments they can only hope! Shareholders make use of information from the annual financial statements to calculate ratios such as Return on Assets (ROA) to evaluate managements' investment policies. Having briefly considered what companies appear to do in practice, the relationship between ARR and ROA, and ultimately Return on Equity and Earnings Yield is demonstrated, with the concluding proposal that, despite its faults, ARR has an important role to play in investment decision making.