Question

In: Accounting

Balloons By Sunset (BBS) is considering the purchase of two new hot air balloons so that...

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) $ 492,000
Useful life 10 years
Salvage value $ 42,000
Annual net income generated 43,296
BBS’s cost of capital 11 %


Assume straight line depreciation method is used.

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.)

Solutions

Expert Solution

Answer 1.

Initial Investment = $492,000
Annual Net Income = $43,296

Account Rate of Return = Annual Net Income / Initial Investment
Account Rate of Return = $43,296 / $492,000
Account Rate of Return = 8.8%

Answer 2.

Initial Investment = $492,000
Salvage Value = $42,000
Useful Life = 10 years
Annual Net Income = $43,296

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = ($492,000 - $42,000) / 10
Annual Depreciation = $45,000

Annual Net Cash Flow = Annual Net Income + Annual Depreciation
Annual Net Cash Flow = $43,296 + $45,000
Annual Net Cash Flow = $88,296

Payback Period = Initial Investment / Annual Net Cash Flow
Payback Period = $492,000 / $88,296
Payback Period = 5.57 years

Answer 3.

NPV = -$492,000 + $88,296 * PVA of $1 (11%, 10) + $42,000 * PV of $1 (11%, 10)
NPV = -$492,000 + $88,296 * 5.8892 + $42,000 * 0.3522
NPV = $42,785

Answer 4.

NPV = -$492,000 + $88,296 * PVA of $1 (14%, 10) + $42,000 * PV of $1 (14%, 10)
NPV = -$492,000 + $88,296 * 5.2161 + $42,000 * 0.2697
NPV = -$20,112


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