Final answer:
The accounting rate-of-return is a straightforward method that compares the expected profit of a project to the investment, expressed as a percentage. It accommodates risk assessment and enables easy comparison of profitability across different projects, aiding in investment decisions.
Step-by-step explanation:
The advantages of the accounting rate-of-return (ARR) approach to project evaluation include its straightforward calculation and focus on accounting profits. The ARR calculates expected returns based on the income a project is anticipated to generate compared to the investment amount. It is expressed as a percentage, which makes it easy to compare across different projects or investment opportunities. The method also incorporates the concept of risk as it relates to the uncertainty of achieving projected profits. Multiple types of risk such as default and interest rate risks can be considered. Investments can thus be categorized by the volatility in their expected returns, distinguishing low-risk from high-risk opportunities.For instance, a company like the Big Drug Company might analyze multiple R&D projects with estimated rates of return. These rates are considered in the context of the company's demand for financial capital at various interest rates. This approach simplifies decision-making by enabling the company to project the profitability of each potential project in their portfolio, taking into account not just the private returns but also any potential spillover benefits that would increase the social rate of return.In conclusion, the ARR method aids in understanding and comparing the profitability of distinct projects, allowing for more informed investment decisions and the alignment of investment levels with anticipated returns and associated risks.