What is the formula for the Accounting Rate of Return (ARR)?

The Accounting Rate of Return (ARR) is a financial metric used to evaluate the profitability of an investment. The correct formula for ARR is based on the average annual profits generated by the investment relative to the initial capital costs incurred to secure that investment.

When considering the purpose of ARR, it measures the expected return from an investment as a percentage of the initial investment amount, providing insight into the investment’s financial viability. The focus on average annual profits before financing costs and tax allows for a clearer assessment of the investment's performance without the distortions that these elements can introduce.

Using this context, the first option accurately reflects the calculation of ARR as it aligns with the structure of the formula: it equates the average annual profits before finance costs and tax with the initial capital costs. This approach provides a straightforward means to communicate how effectively the investment generates returns relative to its cost, making it highly valuable for managerial decision-making regarding potential investments.