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)	$	475,000
Useful life		8	years
Salvage value	$	51,000
Annual net income generated		41,325
BBS’s cost of capital		10	%

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 13 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 = 8.7%

Depreciation = ($475000 – 51000) /8 = $53000

Cash Flow = Net Income + Depreciation

                   = $41325 + 53000 = 94325

Accounting Rate of return = (Net Income / Initial Investments) * 100

= ($41325 / 475000) x 100 = 8.7%

2. Payback period =  5.49 Years

= Initial Investment / cash flow

= $475000 / 94325 = 5.04 Years

3. Net present value (NPV) at 10% = $52009 (Positive)

= [ $94325 x (PVAF 10%,8 Years) + $51000 x (PVF 10%,8 Years) ] - $475000

= [ ($94325 x 5.33493 ) + ($51000 x 0.46651) ] - $475000

= $52009 (Positive)

4. Net present value (NPV) at 13% = - $3172 (Negative)

= [ $94325 x (PVAF 13%,8 Years) + $51000 x (PVF 13%,8 Years) ] - $475000

= [ ($94325 x 4.79877 ) + ($51000 x 0.37616) ] - $475000

= - $3172 (Negative)