Question

Falcon Crest Aces (FCA), Inc., is considering the purchase of a small plane to use in its wing-walking demonstrations and aerial tour business. Various information about the proposed investment follows:     

Initial investment	$	310,000
Useful life	$	10	years
Salvage value		25,000
Annual net income generated	$	6,800
FCA's cost of capital		7	%

Assume straight line depreciation method is used.

Required:
Help FCA evaluate this project by calculating each of the following:

1. Accounting rate of return.

3. Help FCA evaluate this project by calculating each of the following: Net present value (NPV).

4. Help FCA evaluate this project by calculating each of the following: Recalculate FCA's NPV assuming the cost of capital is 3 percent.

Answer 1

Solution 1:

Accounting rate of return = Annual net income / Initial investment = $6,800 / $310,000 = 2.19%

Solution 3:

Annual cash inflows = Annual net income + Depreciation = $6,800 + ($310,000 - $25,000) / 10 = $35,300

Computation of NPV - FCA
Particulars	Period	Amount	PV factor at 7%	Present Value
Cash outflows:
Initial investment	0	$310,000.00	1	$310,000
Present Value of Cash outflows (A)				$310,000
Cash Inflows
Annual cash inflows	1-10	$35,300.00	7.02358	$247,932
Salvage value	10	$25,000.00	0.50835	$12,709
Present Value of Cash Inflows (B)				$260,641
Net Present Value (NPV) (B-A)				-$49,359

Solution 4:

Computation of NPV - FCA
Particulars	Period	Amount	PV factor at 3%	Present Value
Cash outflows:
Initial investment	0	$310,000.00	1	$310,000
Present Value of Cash outflows (A)				$310,000
Cash Inflows
Annual cash inflows	1-10	$35,300.00	8.53020	$301,116
Salvage value	10	$25,000.00	0.74409	$18,602
Present Value of Cash Inflows (B)				$319,718
Net Present Value (NPV) (B-A)				$9,718