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)	$	402,000
Useful life		9	years
Salvage value	$	51,000
Annual net income generated		34,572
BBS’s cost of capital		8	%

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.)

Accounting Rate of Return

%

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

Payback Period

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.)

Net Present Value

4. Recalculate the NPV assuming BBS's cost of capital is 11 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.)

Net Present Value

Answer 1

Solution 1:

Accounting rate of return = Average annual income / Average investment

Average investment = (Cost + Salvage) / 2 = ($402,000 + $51,00) / 2 = $226,500

Accounting rate of return = $34,572 / $226,500 = 15.3%

Solution 2:

Annual cash inflows = Net Income + Depreciation = $34,572 + [($402,000 - $51,000)/9] = $73,572

Payback period = Initial investment / Annual cash inflows = $402,000 / $73,572 = 5.46 years

Solution 3:

Computation of NPV - BBS
Particulars	Period	Amount	PV factor at 8%	Present Value
Cash outflows:
Initial investment	0	$402,000.00	1	$402,000
Present Value of Cash outflows (A)				$402,000
Cash Inflows
Annual cash inflows	1-9	$73,572.00	6.24689	$459,596
Salvage value	9	$51,000.00	0.50025	$25,513
Present Value of Cash Inflows (B)				$485,109
Net Present Value (NPV) (B-A)				$83,109

Solution 4:

Computation of NPV - BBS
Particulars	Period	Amount	PV factor at 11%	Present Value
Cash outflows:
Initial investment	0	$402,000.00	1	$402,000
Present Value of Cash outflows (A)				$402,000
Cash Inflows
Annual cash inflows	1-9	$73,572.00	5.53705	$407,372
Salvage value	9	$51,000.00	0.39092	$19,937
Present Value of Cash Inflows (B)				$427,309
Net Present Value (NPV) (B-A)				$25,309