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:  

Initial investment (for two hot air balloons)	$	433,000
Useful life		8	years
Salvage value	$	57,000
Annual net income generated		36,805
BBS’s cost of capital		11	%

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 1 decimal place.)

        

2. Payback period. (Round your answer to 2 decimal places.)

         

3. Net present value (NPV). (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. 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 14 percent. (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. 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	=	-2.4%
2	Payback Period	=	11.76	years
3	Net Present Value	=	$ -2,18,865
4	Net Present Value	=	$ -2,42,281
	Workings:
1	Annual Depreciation	=	(Initial Investment - Scrap Value) / Useful life
		=	($4,33,000 - $57,000) / 8 years
		=	$       47,000
	Average Annual Income	=	Annual Net Income - depreciation
		=	$36,805 - $47,000
		=	$     -10,195
	Accounting Rate of Return	=	Average Annual Income / Initial Investment
		=	$ -10,195 / $ 4,33,000
		=	-2.4%
2	Payback Period	=	Initial Investments / annual Cash flows
		=	$ 4,33,000 / $36,805
		=	11.76	years
3	Net Present Value	=	$ -2,18,865
	Workings:
		Years	Cash Flow	Factor @ 11%	Present Value
	Initial investment	0	$ -4,33,000	1	$ -4,33,000
	Annual cash inflows	1 - 8	$       36,805	5.1461	$   1,89,402
	Salvage Value	8	$       57,000	0.4339	$      24,732
	Net Present Value				$ -2,18,865
4	Net Present Value	=	$ -2,42,281
	Workings:
		Years	Cash Flow	Factor @ 14%	Present Value
	Initial investment	0	$ -4,33,000	1	$ -4,33,000
	Annual cash inflows	1 - 8	$       36,805	4.6389	$   1,70,735
	Salvage Value	8	$       57,000	0.3506	$      19,984
	Net Present Value				$ -2,42,281