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)	$	455,000
Useful life		9	years
Salvage value	$	50,000
Annual net income generated		42,315
BBS’s cost of capital		11	%
1. Accounting rate of return percentage = 2. Payback period. years= 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

Cost of Investment			455000
Less: Salvage value			50000
Depreciable amount			405000
Life			9
Annual depreciation			45000
Annual net income			42315
Add: Depreciation			45000
Annual cash inflows			87315
Initial Investment			455000
Average Investment			252500
(455000+50000)/2
Accounting rate of return: Annual Income/ Average Investment *100
		42315 /252500 *100 = 16.76%
Payback period: Initial Investment / Annual cash inflows
		$ 455000 /87315 = 5.20 years
NPV at 11%
Annual Inflows			87315
Annuity factor for 9 years			5.537
Present value of inflows			483463.2
Add: Present value of Salvage			19545
($ 50000*0.3909)
Present value of Inflows			503008.2
Less: Initial Investment			455000
Net present values at 11%			48008.16
NPV at 14%
Annual Inflows			87315
Annuity factor for 9 years			4.9464
Present value of inflows			431894.9
Add: Present value of Salvage			15375
($ 50000*0.3075)
Present value of Inflows			447269.9
Less: Initial Investment			455000
Net present values at 14%			-7730.08