Question

Falcon Crest Aces (FCA), Inc., is considering the purchase of a small plane to use in its wing-walking demonstrations and aerial tour business. Various information about the proposed investment follows:     

Initial investment	$	140,000
Useful life	$	10	years
Salvage value		10,000
Annual net income generated	$	3,400
FCA's cost of capital		6	%

Assume straight line depreciation method is used.

Help FCA evaluate this project by calculating:

1.) Accounting rate of return and payback period,

2.) Net present value (NPV). Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1 and Recalculate FCA's NPV assuming the cost of capital is 3% percent,

Answer 1

Cost = 140,000

Salvage value = 10,000

Useful life = 10 years

Depreciation under the Straight line method = (cost - salvage value) / useful life

= (140,000 - 10,000) / 10

= 13,000

Annual cash flows = Annual net income + Depreciation

= 3,400 + 13,000

= 16,400

1.

Accounting rate of return = Net income / Investment

= 3,400 / 140,000

= 2.43%

Payback period = Initial investment / Annual cash flows

= 140,000 / 16,400

= 8.54 years

2.

Prsesnt value of cash inflows = (16,400 * PVAF of 3% for 9 years) + (26,400 * PAVF of 3% in year 10)

= (16,400 * 7.786) + (26,400 * 0.744)

= 127,690.4 + 19,614.6

= 147,332

Present value of cash outflows = 140,000

Net present value = Present value of cash inflows - Present value of cash outflows

= 147,332 - 140,000

= 7,332

(*) Cash flows in year 10 = Net income + Depreciation + Salvage value

= 3,400 + 13,000 + 10,000

= 26,400