Question

Baloons By Sunset (85) is considering the purchase of heo new hot air bailoons so th it can espand its desert sunset Yours Vrousiaou thepd Salvage valu Annual net income generated Assume straight ine depreciation method is uned Required 88S evalune this project by caloulating each of the olowing ate of etam (Reund your answer to 1 decimal place Payback ered Roand your answer to 2 decimal places be indicated by a

Answer 1

(1)-Accounting rate of return

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

= ($31,679 / $401,00) x 100

= 7.9%

(2)-Payback Period

Straight Line Depreciation Expense = [Initial Investment – Salvage Value] / Useful Life

= [$401,000 - $58,000] / 7 Years

= $343,000 / 8 Years

= $49,000 per year

Annual Cash Flow = Net Income + Depreciation Expenses

= $31,679 + $49,000

= $80,679

Therefore, the Payback Period = Initial Investment / Annual Cash Inflow

= $401,000 / $80,679 per year

= 4.97 Years

(3)-Net present value (NPV) if the cost of capital is 11%

Net present value = Present Value of annual cash inflows + Present Value of Salvage Value – Initial Investment

= $80,679(PVIAF 11%, 7 Years) + $58,000(PVIF 11%, 7 Years) - $401,000

= ($80,679 x 4.7122) + ($58,000 x 0.4817) - $401,000

= $380,175 + $27,939 - $401,000

= $7,114

(4)-Net present value (NPV) if the cost of capital is 14%

Net present value = Present Value of annual cash inflows + Present Value of Salvage Value – Initial Investment

= $80,679(PVIAF 14%, 7 Years) + $58,000(PVIF 14%, 7 Years) - $401,000

= ($80,679 x 4.2883) + ($58,000 x 0.3996) - $401,000

= $345,976 + $23,177 - $401,000

= -$31,847 (Negative NPV)

NOTE

-The formula for calculating the Present Value Annuity Inflow Factor (PVIFA) is [{1 - (1 / (1 + r)ⁿ} / r], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.

-The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.