Question

PA11-1 Calculating Accounting Rate of Return, Payback Period, Net Present Value, Estimating Internal Rate of Return [LO 11-1, 11-2, 11-3, 11-4]

Balloons By Sunset (BBS) is considering the purchase of two new hot air balloons so that it can expand its desert sunset tours. Various information about the proposed investment follows:  

Initial investment (for two hot air balloons)	$	385,000
Useful life		8	years
Salvage value	$	41,000
Annual net income generated		31,185
BBS’s cost of capital		7	%

Assume straight line depreciation method is used.
  

Required:
Help BBS evaluate this project by calculating each of the following:  

1. Accounting rate of return. (Round your answer to 1 decimal place.)

Accounting rate of return =

2. Payback period. (Round your answer to 2 decimal places.)

Payback period =               years

3. Net present value (NPV). (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

Net present value =

4. Recalculate the NPV assuming BBS's cost of capital is 10 percent. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

Net present value =

Answer 1

Cost of Investment			385000
Less: Salvage value			41000
Depreciable amount			344000
Life			8
Annual Depreciation			43000
Annual Nnet income			31185
Less: Annual Depreciation			43000
Annual Cash inflows			74185
Initial Investmennt			385000
Average Investment			213000
(385000+41000)/2
Accounting rate of return: Average an nual income/ Average investment *100
		$ 31185 /213000 *100 = 14.64%
Payback period: Initial Investment / Annual cash inflows
		$ 385000 /74185 = 5.20 years
Net Present value at 7%
Annual Inflows				74185
Annuity factor for 8 years				5.971
Present value of Inflows				442958.6
Present value of salvage				23862
($41000* 0.582)
Total Present value f inflows				466820.6
Less: Initial Investment				385000
Net Present value at 7%				81820.64
Net Present value at 10%
Annual Inflows				74185
Annuity factor for 8 years				5.3349
Present value of Inflows				395769.6
Present value of salvage				19126.5
($41000* 0.4665)
Total Present value f inflows				414896.1
Less: Initial Investment				385000
NPV at 10%				29896.06