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: A ntincome gre 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 Retum 2. Payback period. (Round your answer to 2 decimal places.) Payback Period 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 10 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

Answer:

1) Accounting rate of return = Annual net income / Initial investment = $24,395/$287,000 = 0.085 = 8.50%
2)Payback period =    4.61 years
Working Notes:
Annual depreciation= (Initial Investment -salvage value)/life
=( $ 287,000 - $ 59,000)/6
= $ 228,000 / 6
= $ 38,000
Annual cash flow = Annual net income + Annual depreciation
= $ 24,396 + $ 38,000 = $ 62,396
Payback period = Initial investment / Annual cash flow
= $ 287,000/ $ 62,396
= 4.59965
=4.60 years
3)Net Present value = $ 31,723
Working Notes:
Salvage value at the end of 6th year = $ 59,000
PVF @ 7% at 6th period	0.6663
PV of Salvage value = Salvage value x PVF @ 7% at 6th period
=59000*0.6663
=39,312
Annual cash flow = $ 62,396
Cumulative PV of 1$ at the end 6th year = 4.7665
PV of annual cash flow = Annual cash flow x Cumulative PV of $ 1 at end 6th year
=62396*4.7665
=$ 279,411
Initial investment = $ 287,000
NPV = PV of Salvage value + PV of annual cash flow - initial investment
NPv = 39,312 + 279,411 - 287,000
NPV = $ 31,723
4)Net Present value = $18,058
Working Notes:
Salvage value at the end of 6th year = $ 59,000
PVF @ 10% at 6th period	0.5645
PV of Salvage value = Salvage value x PVF @ 10% at 6th period
=59000*0.5645
33,305
Annual cash flow = $ 62,396
Cumulative PV of 1$ @ 10% at the end 7th year = 4.3553
PV of annual cash flow = Annual cash flow x Cumulative PV of $ 1 at end 7th year
=62396*4.3553
= $ 271,753
Initial investment = $ 287,000
NPV = PV of Salvage value + PV of annual cash flow - initial investment
NPv = 33,305 + 271,753 - 287,000
NPV = $ 18,058