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 13 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) $ 307,000 Useful life 7 years Salvage value $ 55,000 Annual net income generated 28,551 BBS’s cost of capital 10 %

Explanation / Answer

Solution 1:

Accounting rate of retuen = Average accouting profit / Average investment

Average accounting profit = $28,551

Average investment = ($307,000 + $55,000)/2 = $181,000

Accounting rate of return (ARR) = $28,551 / $181,000 = 15.8%

Solution 2:

Annual depreciation using SLM = (Cost - Salvage Value) / Life = ($307,000 - $55,000) / 7 = $36,000

Annual cash flows = Annual net income + Depreciation = $28,551 + $36,000 = $64,551

Payback period = 4 + ($307,000 - $258,204) / $64,551 = 4.76 years

Solution 3:

Solution 4:

Computation of cumulative Cash Flows Period Cash flows Cumulative Cash Flows 1 $64,551.00 $64,551.00 2 $64,551.00 $129,102.00 3 $64,551.00 $193,653.00 4 $64,551.00 $258,204.00 5 $64,551.00 $322,755.00 6 $64,551.00 $387,306.00 7 $119,551.00 $506,857.00

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