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Based on these factors, ROI calculations determine whether and by how much the value of future cash inflows associated with a proposed investment will exceed the cash out-flows – that is, the amount of money that an organization must spend or forego to obtain the cash inflows. Simply defined, the ROI is the to-tal of cash inflows minus the amount of the investment. ROI calculations yield a figure of merit – a numeric value that summarizes the economic characteristics of an investment. The figure of merit can then be compared to predetermined acceptance criteria. The typical organization has a wider range of investment opportu-nities than its financial resources can support. Financial management is concerned with the most profitable allocation of such resources. Records management projects must conse-quently compete with many other business activities for available funds. As their principal advantage for decision-makers, ROI calculations facilitate comparison and ranking of competing investment proposals that vary in purpose, scope, or amount. For records management projects, such comparisons and rankings are often performed by corporate financial officers, investment analysts, or others who have little or no knowledge of records management concepts or the objectives of the proposed investment. In such cases, ROI procedures are straightforward: • Costs are determined for each proposed investment, and figures of merit are calculated. • The figures of merit for each proposal are judged against pre-determined acceptance criteria. • Figures of merit for competing proposals judged to be acceptable are compared to one another. Two simple measures of ROI, the accounting rate of return (ARR) and the payback period , are easily applied and widely used, despite some limita-tions, for many records management projects. Both methods provide a quick ROI assessment for a proposed investment. The required rate of return is also known as the minimum acceptable rate of return (MARR) or the hurdle rate. To be considered acceptable, the ARR for a given in-vestment must equal or exceed an organization’s hurdle rate. Accounting Rate of Return The ARR is an easily calculat-ed estimate of a project’s financial viability. Also known as the accoun-tants’ rate of return , the average rate of return , or the simple rate of return , it calculates the anticipated return on a proposed project as a percentage of the original investment amount; the higher the percentage, the more likely a project is to be approved. The formula for the ARR is: ARR = (CI ÷ I) ∞ 100 where: ARR = the accounting rate of return as a percentage value; C = the net annual cash in-flows, in the form of revenues or savings associated with an investment after all expenses are considered; and I = the investment amount. Thus, if an investment (I) of $200,000 in an e-mail archiving ap-plication will yield a net annual cash inflow (CI) of $40,000, the annual rate of return would be: ARR = ($40,000 ÷ $200,000) ∞ 100 ARR = 0.20 ∞ 100 ARR = 20% Like other ROI measures, the ARR is a screening mechanism for acceptable investments. The ARR evaluates competing projects against a predetermined financial standard, without regard to the projects’ objectives. The AAR, calculated by the ARR formula, must be compared to a predetermined required rate of return – that is, the ROI, expressed as an annual percentage rate, that is necessary to justify an investment. Minimum Acceptable Rate of Return The required rate of return is also known as the minimum acceptable rate of return (MARR) or the hurdle rate. To be considered acceptable, the ARR for a given investment must equal or exceed an organization’s hurdle rate. When comparing two or more projects, the one with the highest ARR that equals or exceeds the hurdle rate is preferred. Cost of Capital The required rate of return is usually based on an organization’s cost of capital, which is the mini-mum amount that an organization must earn to satisfy its providers of capital. For a project to be considered justifiable, its ARR must be greater than the cost of capital. For government agencies and other nonprofit organizations, the cost of capital is equal to the orga-nization’s borrowing rate – that is, the interest it must pay on borrowed funds. If a government agency’s bor-rowing rate is 8%, for example, the MARR for investments in records management projects will be 8%. In for-profit companies, the required rate of return usually is a composite of debt capital and equity capital. Debt capital is the company’s after-tax borrowing rate. Because interest paid on business loans is tax-deductible, the after-tax bor-rowing rate on a 12% loan is 7.2%, assuming a corporate tax rate of 40%. Equity capital, which is based on common stock, can prove difficult to estimate because funds obtained from stockholders do not carry a firm commitment regarding future payments. To simplify determination of the required rate of return, some companies use their pretax borrowing rate as an approximate composite of debt capital and equity capital. January/February 2018 41

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