Robert Beaupre spent four years editing a variety of personal finance websites at QuinStreet, culminating in a role as senior editorial manager of the company's insurance sites and managing editor of Insure.com. He then served as an online media manager for the University of Nevada, Reno, writing and optimizing web content for the school's recruitment efforts. Show Certified financial planner | financial planning, investing, family investing, retirement, wealth management Jody D’Agostini, financial advisor with Equitable Advisors, focuses her practice in the areas of comprehensive financial planning and wealth management for individuals and closely held businesses using a goal-based, holistic approach to their finances. She specializes in the areas of retirement and estate planning, having obtained a certificate in retirement planning from the Wharton School at the University of Pennsylvania. D’Agostini has been working with family law attorneys and mediators for over 15 years providing insight into the financial issues surrounding divorce to assist individuals in achieving a fair and equitable settlement, but most importantly to assist in making decisions that give them a clear view of their future and a path toward achieving their life goals. She helps them feel empowered to move forward towards a brighter future. At NerdWallet, our content goes through a rigourous editorial review process. We have such confidence in our accurate and useful content that we let outside experts inspect our work. Average Rate of Return (ARR) refers to the percentage rate of return expected on investment or asset is the initial investment cost or average investment over the life of the project. The formula for an average rate of return is derived by dividing the average annual net earnings after taxes or return on the investment by the original investment or the average investment during the life of the project and then expressed in terms of percentage. Table of contents
Average Rate of Return FormulaMathematically, it is represented as, Average Rate of Return formula = Average Annual Net Earnings After Taxes / Initial investment * 100% or Average Rate of Return formula = Average annual net earnings after taxes / Average investment over the life of the project * 100% You are free to use this image on your website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked ExplanationThe formula for the calculation of the average return can be obtained by using the following steps:
ExamplesLet’s see some simple to advanced examples for calculating the Average Return Formula to understand it better. You can download this Average Rate of Return Formula Excel Template here – Average Rate of Return Formula Excel Template Example #1Let us take the example of real estate investment that is likely to generate returns of $25,000 in Year 1, $30,000 in Year 2, and $35,000 in Year 3. The initial investment is $350,000, with a salvage valueSalvage ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company's machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000.read more of $50,000 and estimated life of 3 years. Do the Calculation the Avg rate of return of the investment based on the given information. Average annual earnings of the real estate investment can be calculated as, Average annual return = Sum of earnings in Year 1, Year 2 and Year 3 / Estimated life = ($25,000 + $30,000 + $35,000) / 3 = $30,000 Therefore, the calculation of the average rate of return of the real estate investment will be as follows,
Therefore, the ARR of the real estate investment is 10.00%. Example #2Let us take an example of an investor who is considering two securities of a comparable risk level to include one of them in his portfolio. Determine which security should be selected based on the following information: Average annual earnings for security A can be calculated as, Average annual earnings A = Sum of earnings in Year 1, Year 2 and Year 3 / Estimated life = ($5,000 + $10,000 + $12,000) / 3 = $9,000 The calculation of ARR of Stock A can be done as follows,
ARR for Stock A
Average annual earnings for security B can be calculated as, Average annual earnings B = ($7,000 + $12,000 + $14,000) / 3 = $11,000 The calculation of the average rate of return for Stock B can be done as follows,
Average Return for Stock B will be –
Based on the given information, Security A should be preferred for the portfolio because of its higher average return than Security B. CalculatorYou can use the following Calculator. Average Annual Net Earnings After TaxesInitial InvestmentAverage Rate of Return Formula = Average Rate of Return Formula ==Average Annual Net Earnings After TaxesX100Initial Investment0X100=00 Relevance and UseIt is important to understand the concept of the average rate of return as it is used by investors to make decisions based on the likely amount of return expected from an investment. Based on this, an investor can decide whether to enter into an investment or not. Further, investors use this return for ranking the assets and eventually make the investment as per the ranking and include them in the portfolio. In projects, an investor uses the metric to check whether or not the average rate of return is higher than the required rate of return, which is a positive signal for the investment. Again, for mutually exclusive projectsMutually Exclusive ProjectsMutually Exclusive Projects is a term that is commonly used in the capital budgeting process where companies choose a single project based on certain parameters from a set of projects where acceptance of one project results in rejection of the other projects.read more, an investor accepts the one with the highest return. In short, the higher the return, the better is the asset. Recommended ArticlesThis has been a guide to what is the Average Rate of Return. Here we discuss how to calculate the Average Rate of Return and its formula and practical examples and a downloadable excel template. You can learn more about Accounting from the following articles –
|