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)	$	335,000
Useful life		7	years
Salvage value	$	41,000
Annual net income generated		26,800
BBS’s cost of capital		12	%

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 15 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

1. Accounting rate of return = 8%

Depreciation = ($335000 - 41000) / 7 = $42000

Cash Flow = Net Income + Depreciation

                   = $26800 + 42000 = $68800

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

= ($26800 / 335000) * 100 = 8%

2. Payback period = 4.87 Years

= Initial Investment / cash flow

= $335000 / 68800 = 4.87 Years

3. Net present value (NPV) at 12% = - $2,467 (Negative)

= [ $68800 x (PVAF 12%,7 Years) + $41000 x (PVF 12%,7 Years) ] - $335000

= [ ($68800 x 4.56376 ) + ($41000 x 0.45235) ] - $335000

= - $2,467 (Negative)

4. Net present value (NPV) at 15% = - $33,349 (Negative)

= [ $68800 x (PVAF 15%,7 Years) + $41000 x (PVF 15%,7 Years) ] - $335000

= [ ($68800 x 4.16042 ) + ($41000 x 0.37594) ] - $335000

= - $33,349 (Negative)