average rate of return

Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.

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Average Rate of Return

The rate of return on an investment that is calculated by taking the total cash inflow over the life of the investment and dividing it by the number of years in the life of the investment. The average rate of return does not guarantee that the cash inflows are the same in a given year; it simply guarantees that the return averages out to the average rate of return.

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average rate of return

One way of measuring an investment's profitability.To calculate,one takes the total net earnings,divides by the total number of years the investment was held,and then divides that answer by the investment's initial acquisition cost.

Example: Rainer spent $800,000 to buy an apartment building. After deducting all operat- ing expenses, real estate taxes, and insurance, she receives $65,000 in the first year, $71,000 in the second year, $69,000 in the third year, and $70,000 in the fourth year. The total net earnings are $275,000. Divide that number by the 4 years being analyzed, to reach $68,750 as an average annual return. Divide $68,750 by the initial $800,000 investment to calculate the average rate of return of 8.59 percent.

Drawback: The procedure does not take into account the time value of money.The $65,000 received in the first year was more valuable than the $70,000 received in the fourth year,because the $65,000 could have been invested to earn still more money.