Edexcel AS/A‑Level Business Theme 3 Practice Test

The average rate of return (ARR) method of investment appraisal calculates the net return generated by an investment as a percentage of the initial investment cost. This method focuses on evaluating the profitability of an investment over its lifespan by taking the total net income expected from the investment, usually averaged over the years, and dividing it by the initial investment amount.

By expressing this net return as a percentage, the ARR provides investors with a straightforward comparison of the potential profitability of different investment options, allowing them to assess which project offers the best return relative to its cost. This method is particularly useful in helping businesses make decisions by providing a clear numerical value that reflects the efficiency of their investments compared to alternative uses of capital.

Other methods of investment appraisal focus on different aspects; for example, discounted cash flow looks at the present value of future cash flows, net present value assesses the overall value addition adjusted for time, and the payback period measures how quickly an investment will return its original cost without providing a direct profitability percentage.