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)	$	354,000
Useful life		8	years
Salvage value	$	58,000
Annual net income generated		30,798
BBS’s cost of capital		7	%

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 10 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

Requirement 1

Accounting rate of return

= Annual net income/ Average investment

= $30,798/ ((354,000+58,000)/2)

= $30,798/$206,000

= 0.1495 or 14.95%

Requirement 2

Annual cash flows = Annual net income + Annual Depreciation

= 30,798+((354000-58000)/8)

= 30,798+37,000 = $67,798

Payback period

= Initial Investment/ Annual cash flows

= 354,000/$67,798 = 5.22 years

Requirement 3
Year		Annual cash flows	PV factor @7%	PV of cash flows
year 0	Initial investment	-354,000	1.0000	-354,000.00
Year 1 to 8	Annual cash flows	67,798	5.9713	404,842.20
Year 8	Salvage value	58,000	0.5820	33,756.00
NPV				84,598.20
Net present value at 7% = $84,598
Requirement 4
Year		Annual cash flows	PV factor @10%	PV of cash flows
year 0	Initial investment	-354,000	1.0000	-354,000.00
Year 1 to 8	Annual cash flows	67,798	5.3349	361,695.55
Year 8	Salvage value	58,000	0.4665	27,057.00
NPV				34,752.55
Net present value at 10% = $34,753