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)	$	409,000
Useful life		7	years
Salvage value	$	52,000
Annual net income generated		33,947
BBS’s cost of capital		9	%

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 12 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

1	Calculation of Depreciation
	Initial investment	a	$        409,000
	Salvage value	b	$        (52,000)
	Depreciable amount	c	$        357,000
	Useful life (year)		$                     7
	Depreciation	d=c/7	$          51,000
	Calculation of Annual Cashflow
			Amount $
	Net income(PAT)	e=c-d	$          33,947
	Add: Depreciation	f	$          51,000
	Free Cashflow	g=e+f	$          84,947
1	Accounting rate of return= Net income/ Initial investment
	Accounting rate of return= $33,947/ $409,000= 8.30%
2	Calculation of Payback period
		Year	Cash inflows	Cumulative cash inflows
		1	$    84,947.00	$    84,947.00
		2	$    84,947.00	$ 169,894.00
		3	$    84,947.00	$ 254,841.00
		4	$    84,947.00	$ 339,788.00
		5	$    84,947.00	$ 424,735.00
		6	$    84,947.00	$ 509,682.00
		7	$ 136,947.00	$ 646,629.00
	Initial investment		$        409,000
	Recovered in 4th year		$        339,788
	Unrecovered		$          69,212
	Payback period= 4+($69,212/$84,947)= 4.81 years
3	Calculation of NPV
		Year	Cash inflows	Present Value Factor @9%p.a.	Discounted Cash flows/ Present value
		1	$    84,947.00	0.91743	$         77,933
		2	$    84,947.00	0.84168	$         71,498
		3	$    84,947.00	0.77218	$         65,595
		4	$    84,947.00	0.70843	$         60,179
		5	$    84,947.00	0.64993	$         55,210
		6	$    84,947.00	0.59627	$         50,651
		7	$ 136,947.00	0.54703	$         74,915
		Present value of cash inflow	$       455,980
		Less: Initial Investment			$     (409,000)
		NPV	$         46,980
4	Calculation of NPV
		Year	Cash inflows	Present Value Factor @12%p.a.	Discounted Cash flows/ Present value
		1	$    84,947.00	0.89286	$         75,846
		2	$    84,947.00	0.79719	$         67,719
		3	$    84,947.00	0.71178	$         60,464
		4	$    84,947.00	0.63552	$         53,985
		5	$    84,947.00	0.56743	$         48,201
		6	$    84,947.00	0.50663	$         43,037
		7	$ 136,947.00	0.45235	$         61,948
		Present value of cash inflow	$       411,200
		Less: Initial Investment			$     (409,000)
		NPV	$            2,200

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