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: (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.)

Initial investment (for two hot air balloons)	$	440,000
Useful life		9	years
Salvage value	$	44,000
Annual net income generated		33,880
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 2 decimal places.)
2. Payback period. (Round your answer to 2 decimal places.)
3. Net present value (NPV). (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. (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

Answer 1

Answer-1)- Accounting rate of return = (Annual net income/Initial investment)*100

= ($33880/$440000)*100

= 7.7%

2)- Pay back period = Initial investment/Annual net cash flow

= $440000/$77880

= 5.65 years

Where- Annual net cash inflow = Net income+ Annual depreciation

= $33880+$44000

= $77880

Straight line Method-Annual depreciation

= Cost of asset- Salvage value of asset/No. of useful life (years)

=($440000-$44000)/9 years

= $396000/9 years

= $44000

3)- Net present value = $8422

Explanation-Net present value = Present value of cash inflows – Total outflows

= ($77880*5.5370)+($44000*0.3909)-$440000

= ($431222+$17200)-$440000

= $448422-$440000

= $8422

Where- Annual net cash inflow = Net income+ Annual depreciation

4)- Net present value assuming 14% cost of capital = $(41244).

Explanation-Net present value = Present value of cash inflows – Total outflows

= ($77880*4.9464)+($44000*0.3075)-$440000

= ($385226+$13530)-$440000

= $398756-$440000

= $(41244)

Where- Annual net cash inflow = Net income+ Annual depreciation