Question

What are the Problems associated with the Accounting Rate of Return methodologies for making capital budgeting decisions?? Why do we learn them if there are so many issues?

Answer 1

Accounting rate of return have different problems as follows-

A. Accounting rate of return does not consider the cash flow timing so it is not considering the the time value factor in its overall analysis

B. Accounting rate of return are also not considering the increased risk of acceptance of a long-term project

C. Accounting rate of return are also not considering the increased uncertainty and risk associated with the long periods.

Accounting rate of return are adopted because it is the most simple method in order to calculate the rate of return in association with the project and it will be giving with a fair idea about the overall rate of return which is generated out of the project so accounting rate of return is the most easy and the non complex method for calculation of the rate of return and hence it is having an estimated idea about whether to accept the project or not