Question

Balloons By Sunset (BBS) is considering the purchase of two new hot air baloons so thar t can expand its desert sunset tours. Vanous information about the proposed investment follows: Initial investment (or two hot air balloons) 442,000 Sahrage value Annual net income genarated BBSs cost of capial S 55,000 5,360 10% Assume straight Ine depreciation method is used Required: Hep E6s evaluate this project by calculating each of the following: 1. Accounting rate of retum (Round your answer to 1 decimal place.) 2. Payback period. (Round your answer to 2 decimal places.) 597 Years 3. Net present value (NPV) Future Valve of $1 Round the final answer to nearest whole dollar.) of $1.Present Value Annuity of S1.) (Use appropriate factor(s] from the tables provided. Do not round Intermediate calculations. Negative amount should be Indicated by a minus sign. 4. Recakculate the NPV assuring 885's cost af capital s 13 percent (Future Valur af $1 should be indicated by a minus sign. Round the tinal answer to nearest whole dollar) y af S1, Preesert Annuty 1)(Use appropriate factons) from the tables provided. Do not round intermediate calculations. Nogative amount

Answer 1

ANSWER:

(1)

Accounting rate of return = net income/initial investment

= $35360/$442000

= 0.08 or 8%

NOTE: here net income is given which is arrived at after deducting depreciation expenses.

(2)

Payback period = initial investment/annual cash inflow

Annual cash inflow = annual net income + annual depreciation expenses

Annual depreciation expenses by straight line method = (initial cost - salvage value)/useful life

= ($442000 - $55000)/9 = $43000

Therefore,

Annual cash inflow = $35360 + $43000 = $78360

Therefore,

Payback period = $442000/$78360

= 5.64 years

(3)

Net present value (NPV) = present value of annual cash inflow - initial investment

Present value of annual cash inflow = present value of annuity $78360 + present value of salvage value $55000

= ($78360 x 5.759) + ($55000 x 0.424)

= $451275.24 + $23320

= $474595.24

Where, PVAF(10%, 9) = 5.759

PVF(10%, 9) = 0.424

Therefore,

NPV = $474595.24 - $442000

= $32595

(4)

If cost of capital is 13% instead of 10% then,

Present value of annual cash inflow = ($78360 x 5.132) + ($55000 x 0.333)

= $402143.52 + $18315

= $420458.52

Where, PVAF(13%, 9) = 5.132

PVF(13%, 9) = 0.333

Therefore,

NPV = $420458.52 - $442000

= - $21541