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)	$	435,000
Useful life		7	years
Salvage value	$	57,000
Annual net income generated		40,020
BBS’s cost of capital		10	%

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

1)

Initial investment = 435000

Average Accounting Income = 40020

Accounting Rate of Return = 40020/435000 *100 = 9.2%

2)

Payback period = Initial investment/Annual net income generated

= 435000/40020 = 10.87 years

3)

Initial investment = 435000

Present value of annual net income generated = 40020*Present value annuity factor(10%,7)

= 40020*4.8684 = 194833.37

Present value of salvage value = 57000*Present value interest factor(10%,7)

= 57000*0.5131 = 29246.70

Net Present Value (NPV) = Present value of annual net income generated +Present value of salvage value -  Initial investment

= 194833.37+ 29246.70 - 435000 = -210920

4)

Initial investment = 435000

Present value of annual net income generated = 40020*Present value annuity factor(13%,7)

= 40020*4.4226 = 176992.45

Present value of salvage value = 57000*Present value interest factor(13%,7)

= 57000*0.4250 = 24225

Net Present Value (NPV) = Present value of annual net income generated +Present value of salvage value -  Initial investment

= 176992.45+24225 - 435000 = -233783