Question

PA11-1 Calculating Accounting Rate of Return, Payback Period, Net Present Value, Estimating Internal Rate of Return [LO 11-1, 11-2, 11-3, 11-4] 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: $ 507,000 9 years $ 48,000 40,560 9% Initial investment (for two hot air balloons) Useful life Salvage value Annual net income generated BBS's cost of capital Assume straight line depreciation method is used. Required: Help BBS evaluate this project by calculating each of the followinh: 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

Answer 1

Initial Investment = $507,000
Salvage Value = $48,000
Useful Life = 9 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = ($507,000 - $48,000) / 9
Annual Depreciation = $51,000

Annual Net Cash Flow = Annual Net Income + Annual Depreciation
Annual Net Cash Flow = $40,560 + $51,000
Annual Net Cash Flow = $91,560

Answer to Requirement 1:

Accounting Rate of Return = Annual Net Income / Initial Investment
Accounting Rate of Return = $40,560 / $507,000
Accounting Rate of Return = 8.0%

Answer to Requirement 2:

Payback Period = Initial Investment / Annual Net Cash Flow
Payback Period = $507,000 / $91,560
Payback Period = 5.54 years

Answer to Requirement 3:

Cost of Capital = 9%

Net Present Value = -$507,000 + $91,560 * PVA of $1 (9%, 9) + $48,000 * PV of $1 (9%, 9)
Net Present Value = -$507,000 + $91,560 * 5.9952 + $48,000 * 0.4604
Net Present Value = $64,020

Answer to Requirement 4:

Cost of Capital = 12%

Net Present Value = -$507,000 + $91,560 * PVA of $1 (12%, 9) + $48,000 * PV of $1 (12%, 9)
Net Present Value = -$507,000 + $91,560 * 5.3282 + $48,000 * 0.3606
Net Present Value = -$1,841