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) | $ | 350,000 | |||||
Useful life | 8 | years | |||||
Salvage value | $ | 46,000 | |||||
Annual net income generated | 31,150 | ||||||
BBS’s cost of capital | 9 | % | |||||
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.) 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.)
4. Recalculate the NPV assuming BBS's cost of
capital is 12 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.)
1. Accounting rate of return = 8.9%
Depreciation = ($350000 - 46000) / 8 = $38000
Cash Flow = Net Income + Depreciation
= $31150 + 38000 = $69150
Accounting Rate of return = (Net Income / Initial Investments) * 100
= ($31150 / 350000) x 100 = 8.9%
2. Payback period = 5.06 Years
= Initial Investment / cash flow
= $350000 / 69150 = 5.06 Years
3. Net present value (NPV) at 9% = $55,819
= [ $69150 x (PVAF 9%,8 Years) + $46000 x (PVF 9%,8 Years) ] - $350000
= [ ($69150 x 5.53482 ) + ($46000 x 0.50187) ] - $350000
= $55,819
4. Net present value (NPV) at 12% = $12,090
= [ $69150 x (PVAF 12%,8 Years) + $46000 x (PVF 12%,8 Years) ] - $350000
= [ ($69150 x 4.96764 ) + ($46000 x 0.40388) ] - $350000
= $12,090
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