In: Accounting
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.)
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