Page 177 - DMGT521_PROJECT_MANAGEMENT

Project Management

Notes Step 3: Average Accounting Income = ( 16 + 60 + 45 ) / 3
= 40.333
Step 4: Accounting Rate of Return = 40.333 / 220 = 18.3%
Project B:

Step 1: Annual Depreciation = (198 – 18) / 3 = 60
Step 2:

Year 1 2 3
Cash Inflow 87 110 84
Salvage Value 18
Depreciation* –60 –60 –60
Accounting Income 27 50 42

Step 3: Average Accounting Income = ( 27 + 50 + 42 ) / 3
= 39.666

Step 4: Accounting Rate of Return = 39.666 / 198 H – 20.0%
Since the ARR of the project B is higher, it is more favorable than the project A.
Advantages and Disadvantages

Advantages:

1. Like payback period, this method of investment appraisal is easy to calculate.

2. It recognizes the profitability factor of investment.
Disadvantages:

1. It ignores time value of money. Suppose, if we use ARR to compare two projects having
equal initial investments. The project which has higher annual income in the latter years
of its useful life may rank higher than the one having higher annual income in the beginning
years, even if the present value of the income generated by the latter project is higher.
2. It can be calculated in different ways. Thus there is problem of consistency.
3. It uses accounting income rather than cash flow information. Thus it is not suitable for
projects which having high maintenance costs because their viability also depends upon
timely cash inflows.

Task Discuss about NPV.

10.3 Net Present Value

In finance, the Net Present Value (NPV) or Net Present Worth (NPW) of a time series of cash
flows, both incoming and outgoing, is defined as the sum of the Present Values (PVs) of the
individual cash flows of the same entity.

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