Which of the following is NOT an advantage of the average rate of return method when evaluating investment projects?

• A. It uses readily available accounting data.
• B. It is simple to calculate and understand.
• C. It considers the time value of money.
• D. It does not require cash flow estimation.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the average rate of return (ARR) method. The ARR method evaluates investment projects by comparing the average annual accounting profit to the initial investment or average investment. It is a straightforward method that uses accounting data, making it simple to calculate and understand.
2. Step 2: Recognize the advantages of the ARR method. These include its simplicity, reliance on readily available accounting data, and ease of understanding for stakeholders. These features make it a popular choice for basic investment evaluations.
3. Step 3: Identify the limitations of the ARR method. One major drawback is that it does not consider the time value of money, which is a critical factor in investment decision-making. The ARR method focuses solely on accounting profits rather than cash flows, which can lead to less accurate evaluations.
4. Step 4: Analyze the options provided in the question. The correct answer should highlight a characteristic that is NOT an advantage of the ARR method. Among the options, 'It considers the time value of money' is incorrect because the ARR method does not account for the time value of money.
5. Step 5: Conclude that the correct answer is 'It considers the time value of money,' as this is not an advantage of the ARR method. The method does not require cash flow estimation, but this is not relevant to the question since it is not listed as an advantage.