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 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. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

Initial investment (for two hot air balloons) $ 329,000 Useful life 6 years Salvage value $ 53,000 Annual net income generated 28,294 BBS’s cost of capital 12 %

Explanation / Answer

1 calculation of accounting rate of return depreciation cost - salvage value / number of years 329000 - 53000 / 6 46000 cash flows per year annual net income + depreciation 28294 + 46000 74294 accounting rate of return annual net income / initial investment 28294 / 329000 8.6% 2 calculation of payback period years 1 2 3 4 5 6 annual cash flows 74294 74294 74294 74294 74294 74294 cumulative annual cash flows 74294 148588 222882 297176 371470 445764 payback period is the time required to collect the initial cost initial cost 329000 cumulative cash flows till 4 year 297176 balance net come to be collected in 5 th year 329000 - 297176 31824 time required to collect the cash flows in 5 th year 31824 / 74294 0.43 payback period 4 years + 0.43 years 4.43 years 3 calculation of net present value 1 years 1 2 3 4 5 6 2 cash flows 74294 74294 74294 74294 74294 74294 3 salvage value 53000 4 total cash flows ( 2 + 3 ) 74294 74294 74294 74294 74294 127294 5 PVRF at 12 % 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 6 present value cash flows ( 2 * 3 ) 66333.93 59226.72 52881.00 47215.18 42156.41 64491.10 7 total present value cash flows 332304.35 8 initial outlay -329000 9 net present value ( 7 + 8 ) 3304 4 calculation of net present value 1 years 1 2 3 4 5 6 2 cash flows 74294 74294 74294 74294 74294 74294 3 salvage value 53000 4 total cash flows ( 2 + 3 ) 74294 74294 74294 74294 74294 127294 5 PVRF at 15 % 0.8696 0.7561 0.6575 0.5718 0.4972 0.4323 6 present value cash flows ( 2 * 3 ) 64603.48 56176.94 48849.51 42477.84 36937.25 55032.71 7 total present value cash flows 304077.72 8 initial outlay -329000 9 net present value ( 7 + 8 ) -24922

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