Introduction to Average Rate of Return in Investment Appraisal

The video tutorial explains investment appraisal, focusing on the average rate of return (ARR) as a method to evaluate investment projects. It details how ARR is calculated by dividing the average annual return by the initial outlay and converting it to a percentage. The tutorial compares three projects, highlighting the importance of cash flow timing and payback periods. It also discusses the advantages and disadvantages of ARR, noting its simplicity but also its limitations, such as ignoring cash flow timing, opportunity costs, and risk assumptions.

What is the primary reason for using the average rate of return in investment appraisal?

• It considers the riskiness of investments.

• It offers a simple percentage for easy comparison.

• It calculates the exact future value of investments.

• It provides a detailed cash flow analysis.

How is the average annual return calculated in the context of investment projects?

• By multiplying the total net return by the number of years.

• By dividing the total net return by the initial outlay.

• By adding the total net return to the initial outlay.

• By dividing the total net return by the number of years.

In the example provided, which project had the highest average rate of return?

• Project A

• Projects B and C

• Project B

• Project C

What is a significant limitation of the average rate of return method?

• It always overestimates returns.

• It is difficult to calculate.

• It does not consider the timing of cash flows.

• It requires complex financial software.

Why is it important to challenge assumptions when using average rate of return?

• Because it always predicts higher returns.

• Because assumptions may not be as optimistic as expected.

• Because it ignores the initial outlay.

• Because it guarantees a fixed return.