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)	$	408,000
Useful life		8	years
Salvage value	$	48,000
Annual net income generated		36,720
BBS’s cost of capital		8	%

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.) Accounting Rate of Return 2. Payback period. (Round your answer to 2 decimal places.) Payback Period Years 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.) Net Present Value

Answer 1

1.
Depreciation = ($408000 - $48000) / 8 = $45000

Accounting Rate of return = Annual Income / Investment x 100
= 36720 / 408000 x 100 = 9%

It can be calculated using Average Investment
= 36720 / 204000 x 100 = 18%

2.
Cash Flows = Annual Income + Depreciation
= $36720 + 45000 = $81720

Payback Period = Investment / Cash flows
= $408000 / $81720 = 4.99 years

3. Net present value = PV of cash inflows - Investment
PV annuity factor @8% for 8 years = 5.7466, PV factor for 8th year = 0.5403
NPV = $81720 x 5.7466 + 48000 x 0.5403 - 408000 = $87547

4.
PV annuity factor @11% for 8 years = 5.1459, PV factor for 8th year = 0.4339
NPV = $81720 x 5.1459 + 48000 x 0.4339 - 408000 = $33350