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)	$	307,000
Useful life		7	years
Salvage value	$	55,000
Annual net income generated		28,551
BBS’s cost of capital		10	%

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 13 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

Solution 1:

Accounting rate of retuen = Average accouting profit / Average investment

Average accounting profit = $28,551

Average investment = ($307,000 + $55,000)/2 = $181,000

Accounting rate of return (ARR) = $28,551 / $181,000 = 15.8%

Solution 2:

Annual depreciation using SLM = (Cost - Salvage Value) / Life = ($307,000 - $55,000) / 7 = $36,000

Annual cash flows = Annual net income + Depreciation = $28,551 + $36,000 = $64,551

Computation of cumulative Cash Flows
Period	Cash flows	Cumulative Cash Flows
1	$64,551.00	$64,551.00
2	$64,551.00	$129,102.00
3	$64,551.00	$193,653.00
4	$64,551.00	$258,204.00
5	$64,551.00	$322,755.00
6	$64,551.00	$387,306.00
7	$119,551.00	$506,857.00

Payback period = 4 + ($307,000 - $258,204) / $64,551 = 4.76 years

Solution 3:

Computation of NPV - Ballon by Sunset
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Investment	$307,000.00	0	1	$307,000.00
Present Value of Cash Outflows (A)				$307,000.00
Cash Inflows:
Annual cash inflows	$64,551.00	1-7	4.868419	$314,261.30
Salvage Value	$55,000.00	7	0.513158	$28,223.70
Present Value of Cash Inflows (B)				$342,485.00
Net Present Value (B-A)				$35,485.00

Solution 4:

Computation of NPV - Ballon by Sunset
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Investment	$307,000.00	0	1	$307,000
Present Value of Cash Outflows (A)				$307,000
Cash Inflows:
Annual cash inflows	$64,551.00	1-7	4.42261	$285,484
Salvage Value	$55,000.00	7	0.425061	$23,378
Present Value of Cash Inflows (B)				$308,862
Net Present Value (B-A)				$1,862