Question

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)	$	307,000
Useful life		7	years
Salvage value	$	55,000
Annual net income generated		28,551
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

Average rate of Return = Average Net Income/ Average Investment

Accounting Rate of Return = 28551 / 307000

= 9.3%

1. Pay Back Period = Initial Investment / Annual Cash Flow

Annual cash Flow = Annual Net Income+Depreciation

Annual Depreciation = (Initial Investment ? Scrap Value) ÷ Useful Life in Years

Annual Depreciation =(307000-55000) / 7 = 36000

Annual Cash Flow = 28551 + 36000= 64551

Pay Back Period = 307000 / 64551

= 4.76 Years

1. Calculation of Net Present Value

		Amount of cash Flow	P.V. Factor @ 10%	Present Value
Annual Cash Flow
Salvage value
Initial Investment
Net Present value

1. Calculation of Net Present Value, if Cost of Capital is 13%

		Amount of cash Flow	P.V. Factor @ 13%	Present Value
Annual Cash Flow
Salvage value
Initial Investment
Net Present value