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)	$	417,000
Useful life		9	years
Salvage value	$	48,000
Annual net income generated		33,777
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

Annual depreciation = (417000-48000)/9 = $41000

Annual cash inflow = Net income + depreciation

= 33777+41000 = $74777

a. Accounting rate of return = average profit / average investment

= 33777/(417000+48000)/2 = 14.53%

b. Payback period = initial investment / annual cash inflow

= 417000/74777 = 5.58 years

c.  Present value of annual cash flows (74777*5.995)            448288
     Less: Amount to be invested                                              417000
     Net present value                                                               $31288

d.  Present value of annual cash flows (74777*5.328)            398412
     Less: Amount to be invested                                              417000
     Net present value                                                               $-18588