ABC IB Business Management Paper 1 Practice Test

The question tests a key limitation of using the Accounting Rate of Return to decide on an expansion. ARR looks at accounting profits in relation to accounting investment, but it ignores when cash actually flows in and out. Because it is based on profits rather than cash, non-cash items like depreciation can make a project appear profitable on ARR even when it doesn’t generate real cash. There’s no discounting of future cash receipts, so ARR also fails to reflect the time value of money. As a result, a project could look attractive by ARR while its cash return is weak, which can mislead decision‑makers about the true financial benefit of expanding. This is why ARR is considered a limited or less reliable measure for evaluating expansion opportunities compared with methods that use cash flows and time value, such as NPV or IRR.