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I was going through the old pilot paper and question 3 examiner’s answer stated:
“To manage investor expectations effectively the firm needs to be aware of the impact of the project on
the firm’s reported profitability and this is most accurately reflected by the differential rate of return measure. Accounting
rate of return as normally calculated does not examine the impact of the project on the financial position of the firm but
is restricted to the rate of return the investment offers on the average capital employed.”Could you please explain to me the difference between the differential rate of return and the accounting rate of return?
Because I would think that the profit and investment of the project (that which is the differential when compared to the company’s normal operations) is what is considered in the ARR anyway…
What he is getting at is that from year to year the rate of return will be different (obviously because profits might change from year to year, but more importantly because the balance sheet value of the capital employed is high at the beginning and low at the end). Conventionally we just take the average profit and the average capital employed.
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