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)	$	297,000
Useful life		7	years
Salvage value	$	52,000
Annual net income generated		22,572
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.)

        

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

         

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.)

         

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.)

    

Answer 1

Answer:-1)-Accounting rate of return =(Average accounting income/Total Investment)*100

=($22572/$297000)*100

=7.6%

2)-Pay back period =Total investment/Total cash flow

=$297000/($22572+$35000)

=5.16 years

Total cash flow =Net income + Annual depreciation

Annual depreciation =(Initial investments-Salvage value)/useful life

=($297000-$52000)/7 =$35000

3)- Net present value = Present value of cash inflows – Total outflows

     ={($57572*5.389)+($52000*0.623) - $297000}

     =($310256+$32396) - $297000

     = $342652-$297000

     = $45652

4)- Net present value = Present value of cash inflows – Total outflows

     ={($57572*4.868)+($52000*0.513) - $297000}

     =($280260+$26676) - $297000

     = $306936-$297000

     = $9936