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 Initial investment (for two hot air baloons) Useful life Salvage value Annual net income gonerated BBS's cost of capital 327,000 6 years S 57,000 26,160 12% Assume straight line depreciation method is used. Required: Help BBS evaluate this project by calculating each of the folowing 1. Accounting rate of return. (Round your answer to 1 decimal place.) Rate of Return 2. Payback period. (Round your answer to 2 decimal places.) Years 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 15 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. Nogative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

Explanation / Answer

1. Accounting rate of return = 8%

Accounting Rate of return = (Net Income / Initial Investments) * 100

Depreciation = ($327000 - $57000) / 6 Years = $45000

Cash Flow = Net Income + Depreciation

                   = $26160 + $45000

                   = $71,160

Accounting Rate of return = ($26160 / $327000) * 100

                                           = 8%

2. Payback period = 4.60 Years

= Initial Investment / cash flow

= $327000 / $71160

= 4.595 Years

or 4.60 Years (Rounded

3. Net present value (NPV) at 12% = - $5,491 (Negative)

= [ $71160 x (PVAF 12%,6 Years) + $57000 x (PVF 12%,6Years) ] - $327000

= [ ($71160x4.112) + ($41000x0.507 ] - $327000

= - $5,491(Negative)

4. Net present value (NPV) at 15% = - $33,035 (Negative)

= [ $71160 x (PVAF 15%,6 Years) + $57000 x (PVF 15%,6Years) ] - $327000

= [ ($71160x3.785) + ($41000x0.432 ] - $327000

= - $33,035(Negative)

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