PA11-1 Calculating Accounting Rate of Return, Payback Period, Net Present Value,
ID: 2600751 • Letter: P
Question
PA11-1 Calculating Accounting Rate of Return, Payback Period, Net Present Value, Estimating Internal Rate of Return [LO 11-1, 1-2, 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: Initial investment (for two hot air balloons) $ 314,000 Useful life 7 years Salvage value $ 55,000 Annual net income generated 28,260 BBS's cost of capital 8% 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.) Accounting Rate of Return 1%Explanation / Answer
1.
Initial Investment for 1 Balloon = $314,000
Accounting Rate of Return = Average Profit / Average Investment
As we know that the Net income and Initial investment is same for all years so the average of them will also same of 1 year.
Accounting Rate of Return = $28,260 / $314,000
Accounting Rate of Return = 9%
2.
Depreciation = (Cost – Salvage Value) / Useful life
= (314,000– 55,000) / 7 Years
= 37,000 per year
Cash inflow per year = Net income + Depreciation
= $28,260 + 37,000
Cash inflow per year = $65,260
Year
Inflow per year
Cumulative Cash inflow
1
65,260
65,260
2
65,260
130,520
3
65,260
195,780
4
65,260
261,040
5
65,260
326,300
6
65,260
391,560
7
65,260
456,820
As we can see that we will receive $314,000 between 4 and 5 years
Payback period = Initial cash outflow / Cash inflow per year
= 4 Years + [(314,000 - 261,040)/ 65,260]
= 4 Years + 0.81 Years
Payback period = 4.81 Years
3.
Cost of Capital = 8%
PVAF @8% for 7 Years = 5.206
PVF @8% of 7th Year = 0.583
Present Value of Cash Inflow = (Annual cash inflow * PVAF @8% for 7 Years) + (Salvage Value * PVF @8% of 7th Year)
= (65,260 * 5.206) + (55,000 * 0.583)
= 339,743.56 + 32,065
Present Value of Cash Inflow = 371,808.56
NPV = Present Value of Cash Inflow – Initial Cash outflow
= 371,808.56 – 314,000
NPV = $57,808.56
4.
Cost of Capital = 11%
PVAF @11% for 7 Years = 4.712
PVF @11% of 7th Year = 0.482
Present Value of Cash Inflow = (Annual cash inflow * PVAF @11% for 7 Years) + (Salvage Value * PVF @11% of 7th Year)
= (65,260 * 4.712) + (55,000 * 0.482)
= 307,505.12 + 26,510
Present Value of Cash Inflow = 334,015.12
NPV = Present Value of Cash Inflow – Initial Cash outflow
= 334,015.12– 314,000
NPV = $20,015.12
Year
Inflow per year
Cumulative Cash inflow
1
65,260
65,260
2
65,260
130,520
3
65,260
195,780
4
65,260
261,040
5
65,260
326,300
6
65,260
391,560
7
65,260
456,820
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