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)	$	261,000
Useful life		6	years
Salvage value	$	45,000
Annual net income generated		21,141
BBS’s cost of capital		8	%

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 11 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.

Accounting rate of return = Net income/ Investment

                                        = $ 21,141/$ 261,000 = 0.081 or 8.1 %

2.

Annual depreciation = (Cost of asset – Salvage value)/ Number of useful years

                                   = ($ 261,000 - $ 45,000)/6

                                 = $ 216,000/6 = $ 36,000

Annual cash flow = Net income + Annual depreciation

                                = $ 21,141 + $ 36,000 = $ 57,141

Payback period = Initial investment/Annual cash flow

                          = $ 216,000/$ 57,141

                          = 4.567648449 or 4.57 years

3.

NPV = PV of cash inflows – Initial investment

       = $ 57,141 x PVIFA (8 %, 6) + $ 45,000 x PVIF (8 %, 6) - $ 216,000

     = $ 57,141 x 4.62288 + $ 45,000 x 0.63017 - $ 216,000

      = $ 264,155.98608 + $ 28,357.65 - $ 216,000

      = $ 292,513.63608 - $ 216,000

= $ 31,513.63608 or $ 31,513.64

4.

NPV = PV of cash inflows – Initial investment

       = $ 57,141 x PVIFA (11 %, 6) + $ 45,000 x PVIF (11 %, 6) - $ 216,000

     = $ 57,141 x 4.23054 + $ 45,000 x 0.53464 - $ 216,000

      = $ 241,737.28614 + $ 24,058.80 - $ 216,000

      = $ 265,796.08614 - $ 216,000

      = $ 4,796.08614 or $ 4,796.09