PA11-1 Calculating Accounting Rate of Return, Payback Period. Net Present Value,
ID: 2432971 • Letter: P
Question
PA11-1 Calculating Accounting Rate of Return, Payback Period. Net Present Value, Estimating Internal Rate of Return(LO 11-1, 11-2, 11-3, 11-4] Ballons 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 ollows: Initial investment (for two hot air balloons) 355,000 Useful ife Salvage value Annual net income generated 88S's cost of capital years $ 54,000 32,305 10% 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.) earsExplanation / Answer
Solution:
1.Accounting Rate of Return=15.8%(see working note 1)
2.Payback period=4.71 years (see working note 2)
3 Net Present Value=$ 11,615(see working note 3)
4. Net Present Value when cost of capital is 13%= -$21,949(see working note 4)
WORKING NOTES:
1).Accounting Rate of Return( ARR)= Average Net Profit/Average Investment
Initial Investment= $ 3,55,000
Salvage value= $ 54,000
Useful Life= 7years , Depreciation= ($ 3,55,000-$ 54,000)/7 =$ 43,000
Average Investment= (Book value at year1+ book value at the end of the useful life)/2
=($3,55,000+$ 54000)/2= $ 2,04,500
Average annual profit=Total profit over the investment period/number of years
=$ 32,305
Therefore ARR= $32305*100/$ 204500= 15.8%
2.)Payback Period:
Annual cash flow= Annual net income+ annual depreciation
=$ 32,305+ $ 43,000 = $ 75305
Therefore Payback period= Initial Investment/Annual cash flow=$ 3,55,000/$ 75305= 4.71 years
3)Net Present Value when cost of capital=10%
Initial Investment= $ 3,55,000
Net cash inflow per period= $ 75305
Number of periods=7 years
Discount Rate per period=10%
Net Present Value= $ 75305( 0.9091+0.8264+0.7513+0.6830+0.6209+0.5645+0.5132)-$ 3,55,0000=$11614.86= $ 11,615
4)Net Present Value when cost of capital=13%
Net Present Value=$ 75,305(0.8850+0.7831+0.6931+0.6133+0.5428+0.4803+0.4251)-$ 355000
=-$21,948.58 i.e= -$21,949
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