Rates of return are always quoted as annual rates. In other words, what percentage of the amount invested
would be earned on this investment if the investment were held for one full year
When the income received is for an investment that was held for less than one full year, the amountof income must be annualizedExamples:
#1: An investor invests $10,000 for one year and earns a $500 return on the investment. At the end of
one year, the investor receives back $10,500. The investor's rate of return on the investment is the $500
income received divided by the $10,000 invested:
Annual Rate of Return =
$500 / 10,000
= 0.05 or 5%
#2: If the investor invests $10,000 for only 6 months and earns $250 on the investment, the rate of
return is still 5%. The $250 that was received for 6 months must be annualized by multiplying it by 2
since there are two 6-month periods in one year. The ($250 × 2) is then divided by the amount invested
to calculate the annual rate.
Annual Rate of Return =
$250 × 2 / 10,000
= 0.05 or 5%
#3: Next, suppose the investor invests $10,000 for 3 months, then withdraws $4,000 and leaves the
remaining $6,000 on deposit for another 3 months. At the end of 6 months, the investor withdraws the
remaining $6,000 along with income received of $200. What is the investor's rate of return?
The average balance of the investment over the 6-month term was [($10,000 × 3) + ($6,000 × 3)] ÷
6 = $8,000. The amount of income received for those 6 months was $200, and that is equal to $400
when it is annualized (multiplied by 2). The annual rate of return is the annualized income for six months
multiplied by 2, the result divided by the average balance of $8,000
Annual Rate of Return =
$200 × 2 / 8,000
= 0.05 or 5%
Calculation of an annual rate of return is a "what if" exercise. The annual rate of return is the rate that
would have been earned if the same amount of money had been invested for one year, on the same
terms ($10,000 half of the time and $6,000 half of the time), and income on the investment had been
earned at the same rate throughout the year as it was earned during the 6 months the money was
actually invested.
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Adnan
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Original Message:
Sent: 10-23-2022 08:47 PM
From: Idrees Bino
Subject: Accounting rate of return calculation
Hello folk.
I'm facing a problem with the calculation of Accounting Rate of Return, some times the average net income is divided by the (Average investment) : initial investment divided by 2); in other situations, the average net income is divided by the initial investment itself, not using the average.
is it a bug in the exam prep software? or it is something else, like the equipment of the machine (investment) is undepreciatable and holds it's book value constant.
Thanks.
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Idrees Bino
Administrative
Amman - Jordan
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