Question

PA11-1 Calculating Accounting Rate of Return, Payback Period, Net Present Value, Estimating Internal Rate of Return [LO 11-1, 11-2, 11-3, 11-4]

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)   $   432,000
Useful life      9   years
Salvage value   $   45,000     
Annual net income generated      37,152     
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 = 8.6%

Accounting Rate of return = (Net Income / Initial Investments) * 100

Depreciation = ($432000 - $45000) / 9 = $43,000

Cash Flow = Net Income + Depreciation

                   = $37,152 + $43,000

                   = $80,152

Accounting Rate of return = (Net Income / Initial Investments) * 100

                                         = ($37152 / $432000) * 100

                                        = 8.6%

2. Payback period = 5.39 Years

= Initial Investment / cash flow

= $432000 / $80152

= 5.39 Years

3. Net present value (NPV) at 11% = $29,392

= [ $80152 x (PVAF 11%,9 Years) + $45000 x (PVF 11%,9Years) ] - $432000

= [ ($80152x5.5370) + ($45000x0.3909) ] - $432000

=$4,43,802 + $17,590 - $432000

= $29,392 (Rounded)

4. Net present value (NPV) at 14% = - $21698 (Negative)

= [ $80152 x (PVAF 14%,9 Years) + $45000 x (PVF 14%,9Years) ] - $432000

= [ ($80152x4.9464) + ($45000x0.30751 ] - $432000

=$396464 + $13838 - $432000

= - $21698 (Negative) (Rounded)