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)	$	332,000
Useful life		6	years
Salvage value	$	50,000
Annual net income generated		30,876
BBS’s cost of capital		10	%

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 13 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

Answer-1)- Accounting rate of return = 9.3%.

Explanation= Accounting rate of return= (Annual net income/ Initial investment)*100

= ($30876/($332000)*100

= 9.3%

2)- Payback period = 4.26 years.

Explanation- Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.

In case when cash inflow are even, the formula to calculate payback period is:

Payback period =Initial investment / Cash Inflow per period

= $332000/$77876

= 4.26 years

Where- Annual cash inflow = Net income+ Annual depreciation

= $30876+$47000

= $77876

Explanation- Straight line Method- Depreciation Expense Annual

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

=($332000 - $50000)/6 years

=$282000/6 years

= $47000

3)- Net present value = $35350.

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

= ($77876*4.355)+($50000*0.564) - $332000

= ($339149.98+$28200) - $332000

= $367349.98 - $332000

= $35350

4)- Net present value = $3348.

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

= ($77876*3.998)+($50000*0.480) - $332000

= ($311348.248+$24000) - $332000

= $335348.248 - $332000

= $3348