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)	$	420,000
Useful life		10	years
Salvage value	$	50,000
Annual net income generated		37,800
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.

   

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. Round the final answer to nearest whole dollar.)

4. Recalculate the NPV assuming BBS's cost of capital is 15 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. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

Answer 1

Initial Investment = $420,000
Salvage Value = $50,000
Useful Life = 10 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = ($420,000 - $50,000) / 10
Annual Depreciation = $37,000

Annual Net Cash Flow = Annual Net Income + Annual Depreciation
Annual Net Cash Flow = $37,800 + $37,000
Annual Net Cash Flow = $74,800

Answer 1.

Accounting Rate of Return = Annual Net Income / Initial Investment
Accounting Rate of Return = $37,800 / $420,000
Accounting Rate of Return = 9.00%

Answer 2.

Payback Period = Initial Investment / Annual Net Cash Flow
Payback Period = $420,000 / $74,800
Payback Period = 5.61 years

Answer 3.

Cost of Capital = 11%

Net Present Value = -$420,000 + $74,800 * PVA of $1 (11%, 10) + $50,000 * PV of $1 (11%, 10)
Net Present Value = -$420,000 + $74,800 * 5.88923 + $50,000 * 0.35218
Net Present Value = $38,123

Answer 4.

Cost of Capital = 15%

Net Present Value = -$420,000 + $74,800 * PVA of $1 (15%, 10) + $50,000 * PV of $1 (15%, 10)
Net Present Value = -$420,000 + $74,800 * 5.01877 + $50,000 * 0.24718
Net Present Value = -$32,237