Question

Falcon Crest Aces (FCA), Inc., is considering the purchase of a small plane to use in its wing-walking demonstrations and aerial tour business. Various information about the proposed investment follows:     

Initial investment	$	210,000
Useful life	$	10	years
Salvage value		20,000
Annual net income generated	$	4,800
FCA's cost of capital		7	%

Assume straight line depreciation method is used.

Required:
Help FCA evaluate this project by calculating each of the following:

1. Accounting rate of return. (Round your answer to 2 decimal places.)

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. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

4. Recalculate FCA's NPV assuming the cost of capital is 3% 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. Round your final answer to the nearest whole dollar amount.)

5.	Without doing any calculations, what is the project's IRR?

Greater than 7%

Between 3% and 7%

Less than 3%

Answer 1

(1)-Accounting rate of return

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

= ($4,800 / $210,000) x 100

= 2.29%

(2)-Payback Period

Straight Line Depreciation Expense = [Initial Investment – Salvage Value] / Useful Life

= ($210,000 - $20,000) / 10 Years

= $190,000 / 10 Years

= $19,000 per year

Annual Cash Flow = Net Income + Depreciation Expenses

= $4,800 + $19,000

= $23,800

Therefore, the Payback Period = Initial Investment / Annual Cash Inflow

= $210,000 / $23,800

= 8.82 Years

(3)-Net present value (NPV) if the cost of capital is 7%

Net present value = Present Value of annual cash inflows + Present Value of Salvage Value – Initial Investment

= $23,800(PVIAF 7%,10 Years) + $20,000(PVIF 7%,10 Years) - $210,000

= ($23,800 x 7.0236) + ($20,000 x 0.5083) - $210,000

= $167,162 + $10,166 - $210,000

= -$32,672 (Negative NPV)

(4)-Net present value (NPV) if the cost of capital is 3%

Net present value = Present Value of annual cash inflows + Present Value of Salvage Value – Initial Investment

= $23,800(PVIAF 3%,10 Years) + $20,000(PVIF 3%,10 Years) - $210,000

= ($23,800 x 8.532) + ($20,000 x 0.7441) - $210,000

= $203,019 + $14,882 - $210,000

= $7,901

(5)-The Range of IRR will be “Between 3% and 7%”