In: Finance
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) | $ | 415,000 | |||||
Useful life | 9 | years | |||||
Salvage value | $ | 55,000 | |||||
Annual net income generated | 33,615 | ||||||
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.)
(1)-Accounting rate of return
Accounting Rate of return = (Net Income / Initial Investments) x 100
= [$33,615 / $415,000] x 100
= 8.1%
(2)-Payback Period
Straight Line Depreciation Expense = [Initial Investment – Salvage Value] / Useful Life
= [$415,000 - $55,000] / 9 Years
= $360,000 / 9 Years
= $40,000 per year
Annual Cash Flow = Net Income + Depreciation Expenses
= $33,615 + $40,000
= $73,615 per year
Therefore, the Payback Period = Initial Investment / Annual Cash Inflow
= $415,000 / $73,615 per year
= 5.64 Years
(3)-Net present value (NPV) if the cost of capital is 12.00%
Net present value = Present Value of annual cash inflows + Present Value of Salvage Value – Initial Investment
= $73,615(PVIAF 12%, 9 Years) + $55,000(PVIF 12%, 9 Years) - $415,000
= [($73,615 x 5.3282) + ($55,000 x 0.3606)] - $415,000
= [$19,833 + $392,235] - $415,000
= $412,068 - $415,000
= -$2,932 (Negative NPV)
(4)-Net present value (NPV) if the cost of capital is 15.00%
Net present value = Present Value of annual cash inflows + Present Value of Salvage Value – Initial Investment
= $73,615(PVIAF 15%, 9 Years) + $55,000(PVIF 15%, 9 Years) - $415,000
= [($73,615 x 4.7716) + ($55,000 x 0.2843)] - $415,000
= [$15,637 + $351,261] - $415,000
= $366,898 - $415,000
= -$48,102 (Negative NPV)
NOTE
-The formula for calculating the Present Value Annuity Inflow Factor (PVIFA) is [{1 - (1 / (1 + r)n} / r], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.
-The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)n], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.