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)	$	338,000
Useful life		8	years
Salvage value	$	42,000
Annual net income generated		31,434
BBS’s cost of capital		11	%

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 14 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

Required -1 :-

Accounting rate of return :- 1.1625

Accounting rate of return (%) = Total net profit / no of years*100 Initial cost

= 31,434/8*100 338,000

= 1.1625

Required - 2 :-

Payback Period :- 4.94 years

*Annual depreciation = (Initial Investment -salvage value)/life

= ($338,000 - $42,000)/8

= $ 37,000

*Annual cash flow = Annual net income + Annual depreciation

= $31,434 + $37,000

= $68,434.

*Payback period = Initial investment / Annual cash flow

= $338,000 / $68,434

= 4.939

= 4.94 years

Required -3

Net Present Value :- ($2,304)

Working:

Salvage value at the end of 8th year = $ 42,000

PVF @11% at 8th period = 0.4339 .

PV of Salvage value = Salvage value x PVF @ 11% at 8th period

= 42,000 * 0.4339

= 18,223.8

Annual cash flow = $ 68,434

Cumulative PV of $1 @14% at the end of 8th year = 4.6389

PV of annual cash flow = Annual cash flow *  Cumulative PV of $ 1 at end 8th year

= $68,434 * 4.6389

= $317,458

Initial investment = $ 338,000.

NPV = PV of Salvage value + PV of annual cash flow - initial investment

NPV = 18,238 + 317,458 - 338,000

NPV = ($2,304)

Required -4:-

Net Present value = ($5,816.8)

Working:

Salvage value at the end of 8th year = $ 42,000

PVF @ 14% at 8th period = 0.3506

PV of Salvage value = Salvage value x PVF @ 14% at 8th period

= 42,000 * 0.3506

   = 14,725.2

Annual cash flow = $ 68,434.

Cumulative PV of 1$ @ 14% at the end 8th year = 4.6389

PV of annual cash flow = Annual cash flow x Cumulative PV of $ 1 at end 8th year

= 68,434 * 4.6389

= 317,458

Initial investment = $ 338,000

NPV = PV of Salvage value + PV of annual cash flow - initial investment

NPV = 14,725.2 + 317,458 - 338,000

NPV = ($5816.8)