Balloons By Sunset (BBS) is considering the purchase of two new hot air balloons

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:  

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.)

    

Initial investment (for two hot air balloons) $ 433,000 Useful life 8 years Salvage value $ 57,000 Annual net income generated 36,805 BBS’s cost of capital 11 %

Explanation / Answer

1 Accounting Rate of Return = -2.4% 2 Payback Period = 11.76 years 3 Net Present Value = $ -2,18,865 4 Net Present Value = $ -2,42,281 Workings: 1 Annual Depreciation = (Initial Investment - Scrap Value) / Useful life = ($4,33,000 - $57,000) / 8 years = $       47,000 Average Annual Income = Annual Net Income - depreciation = $36,805 - $47,000 = $     -10,195 Accounting Rate of Return = Average Annual Income / Initial Investment = $ -10,195 / $ 4,33,000 = -2.4% 2 Payback Period = Initial Investments / annual Cash flows = $ 4,33,000 / $36,805 = 11.76 years 3 Net Present Value = $ -2,18,865 Workings: Years Cash Flow Factor @ 11% Present Value Initial investment 0 $ -4,33,000 1 $ -4,33,000 Annual cash inflows 1 - 8 $       36,805 5.1461 $   1,89,402 Salvage Value 8 $       57,000 0.4339 $      24,732 Net Present Value $ -2,18,865 4 Net Present Value = $ -2,42,281 Workings: Years Cash Flow Factor @ 14% Present Value Initial investment 0 $ -4,33,000 1 $ -4,33,000 Annual cash inflows 1 - 8 $       36,805 4.6389 $   1,70,735 Salvage Value 8 $       57,000 0.3506 $      19,984 Net Present Value $ -2,42,281

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