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)	$	455,000
Useful life		8	years
Salvage value	$	55,000
Annual net income generated		40,040
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. (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 14 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

Solution 1:

Average Investment = ($455,000 + $55,000) / 2 = $255,000
Accounting rate of Return
Choose Numerator	/	Choose Denominator	=	Accounting Rate of Return
Annual Net Income	/	Average Investment	=	Accounting Rate of Return
$40,040	/	$2,55,000	=	15.7%

Solution 2:

Computation of Annual net Cash Flows
Annual Net Income	$40,040
Annual Depreciation [($455,000-$55,000)/8]	$50,000
Annual Cash Flows	$90,040

Payback Period
Choose Numerator	/	Choose Denominator	=	Payback Period
Cost of investment	/	Annual net Cash flow	=	Payback Period
$4,55,000	/	$90,040	=	5.05
				Years

Solution 3:

Computation of NPV - Balloons By Sunset
Particulars	Amount
Table or calculator function:	Present Value of $1
Cash Outflows (Beginning of year)	-$4,55,000
n=	0
i=	11%
Present Value	-$4,55,000
Table or calculator function:	Present Value of annuityof $1
Cash Inflow (for next 8 years)	$90,040
n=	8
i=	11%
Table Factor	5.14612
Present Value	$4,63,357
Table or calculator function:	Present Value of $1
Cash Inflow (for 8th year)	$55,000
n=	8
i=	11%
Table Factor	0.43393
Present Value	$23,866
Total Net present value	$32,223

Solution 4:

Computation of NPV - Balloons By Sunset
Particulars	Amount
Table or calculator function:	Present Value of $1
Cash Outflows (Beginning of year)	-$4,55,000
n=	0
i=	14%
Present Value	-$4,55,000
Table or calculator function:	Present Value of annuityof $1
Cash Inflow (for next 8 years)	$90,040
n=	8
i=	14%
Table Factor	4.63886
Present Value	$4,17,683
Table or calculator function:	Present Value of $1
Cash Inflow (for 8th year)	$55,000
n=	8
i=	14%
Table Factor	0.35056
Present Value	$19,281
Total Net present value	-$18,036