Question 7 7. Balloons By Sunset (BBS) is considering the purchase of two new ho
ID: 2593629 • Letter: Q
Question
Question 7
7. 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 12 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.)
Question 8
8. After completing a long and successful career as senior vice president for a large bank, you are preparing for retirement. After visiting the human resources office, you have found that you have several retirement options to choose from:
Option A: An immediate cash payment of $1.07 million.
Option B: Payment of $65,000 per year for life.
Option C: Payment of $55,000 per year for 4 years and then $75,000 per year for life (this option is intended to give you some protection against inflation).
You believe you can earn 8 percent on your investments and your remaining life expectancy is 8 years.
Required:
1. Calculate the net present value of each option. (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. Enter your answers in dollars but not in millions. Round the final answer to nearest whole dollar.)
Explanation / Answer
1.
Accounting rate of return = Average profit/Initial investment
= $ 31,914/$ 394,000 = 0.081 or 8.1 %
2. Depreciation = ($ 394,000 - $ 31,914)/10 = $ 362,086/10 = $ 36,208.60
Annual Cash flow = Annual net income + Depreciation
= $ 31,914 + $ 36,208.60 = $ 68,122.60 or $ 68,123
Year
Cash Flow
'Cum Cash Flow
0
$ (394,000)
$ (394,000)
1
$ 68,123
$ (325,877)
2
$ 68,123
$ (257,755)
3
$ 68,123
$ (189,632)
4
$ 68,123
$ (121,510)
5
$ 68,123
$ (53,387)
6
$ 68,123
$ 14,736
7
$ 68,123
$ 82,858
8
$ 68,123
$ 150,981
9
$ 111,123
$ 262,103
Payback period = A + B/C
Where,
A = Last period with a negative cumulative cash flow = 5 years
B = Absolute value of cumulative cash flow at the end of the period A = $ 53,387
C = Total cash flow during the period after A = $ 68,123
Payback period = 5 + $ 53,387/$ 68,123 = 5 + 0.7837 = 5.78 years.
3.
Year
Cash Flow
PV Factor @ 9 %
PV
0
$ (394,000)
1
$ (394,000)
1
$ 68,123
0.917431
$ 62,498
2
$ 68,123
0.841680
$ 57,337
3
$ 68,123
0.772183
$ 52,603
4
$ 68,123
0.708425
$ 48,260
5
$ 68,123
0.649931
$ 44,275
6
$ 68,123
0.596267
$ 40,619
7
$ 68,123
0.547034
$ 37,265
8
$ 68,123
0.501866
$ 34,188
9
$ 111,123
0.460428
$ 51,164
NPV
$ 34,210
NPV is $ 34,210
4.
Year
Cash Flow
PV Factor @12%
PV
0
$ (394,000)
1
$ (394,000)
1
$ 68,123
0.892857
$ 60,824
2
$ 68,123
0.797194
$ 54,307
3
$ 68,123
0.711780
$ 48,488
4
$ 68,123
0.635518
$ 43,293
5
$ 68,123
0.567427
$ 38,655
6
$ 68,123
0.506631
$ 34,513
7
$ 68,123
0.452349
$ 30,815
8
$ 68,123
0.403883
$ 27,514
9
$ 111,123
0.360610
$ 40,072
NPV
$ (15,520)
NPV is - $ 15,520
Year
Cash Flow
'Cum Cash Flow
0
$ (394,000)
$ (394,000)
1
$ 68,123
$ (325,877)
2
$ 68,123
$ (257,755)
3
$ 68,123
$ (189,632)
4
$ 68,123
$ (121,510)
5
$ 68,123
$ (53,387)
6
$ 68,123
$ 14,736
7
$ 68,123
$ 82,858
8
$ 68,123
$ 150,981
9
$ 111,123
$ 262,103
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