# Investment efficiency factor (ALL) - Economic evaluation of investments

## Investment efficiency ratio (ALL)

Another indicator of the static financial evaluation of the project is the investment efficiency factor (Account Rate of Return, ARR). This coefficient is also called the accounting profit rate or the project profitability ratio.

There are several algorithms for calculating ARR.

The first version of the calculation is based on the ratio of the average annual amount of profit (minus deductions to the budget) from the project for the period to the average investment:

where Pr is the annual average profit (minus deductions to the budget) from the project; - the average value of the initial investment, if it is assumed that after the project is over, all capital costs will be written off.

Sometimes the project profitability index is calculated on the basis of the initial investment value:

Based on the initial amount of investment, it can be used for projects that create a stream of unified revenue (for example, annuity) for an indefinite or rather long period.

The second version of the calculation is based on the ratio of the average annual profit (minus deductions to the budget) from the project for the period to the average investment value, taking into account the residual or liquidation value of the initial investment (for example, accounting of the liquidation value of equipment at the completion of the project):

where - the average cost of initial investment; - the residual or liquidation value of the initial investment.

The advantage of the investment efficiency indicator is the simplicity of the calculation. At the same time, the efficiency index of investments has significant shortcomings. It does not take into account the value of money in time and does not involve discounting, therefore, does not take into account the distribution of profit by years, and therefore, it is only applicable to the evaluation of short-term projects with a uniform revenue stream. In addition, in this regard, it is impossible to assess the possible differences in projects associated with different implementation times.

Since the method is based on the use of the accounting characteristics of the investment project - the average annual profit, the investment efficiency coefficient does not quantify the growth of the company's economic potential. However, this coefficient provides information on the impact of investments on the company's financial statements. The indicators of financial statements are sometimes the most important when analyzing the attractiveness of the company by investors and shareholders.

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