Balloons By Sunset (BBS) is considering the purchase of two new hot air balloons
ID: 2530601 • Letter: B
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 balloons) $ 318,000
Useful life 7 years
Salvage value $ 52,000
Annual net income generated 28,302
BBS’s cost of capital 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.)
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 13 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.)
Explanation / Answer
1) Accounting Rate of Return = Annual Net Income/Initial Investment
= $28,302/$318,000 = 8.9%
2) Depreciation Under Straight Line Method = (Initial Investment - Salvage Value)/Useful Life
= ($318,000 - $52,000)/7 yrs = $38,000
Annual Cash Inflows = Annual Net Income+Depreciation per year
= $28,302+$38,000 = $66,302
Payback Period = Initial Investment/Annual Cash Inflows
= $318,000/$66,302 = 4.80 yrs
3) Calculation of NPV if Cost of Capital is 10%
Net Present Value = Present Value of Cash Inflows - Initial Investment
= [Annual Cash Inflows*PVAF(10%, 7 yrs)] - $318,000
= ($66,302*4.86842) - $318,000 = $4,786
Therefore the NPV is $4,786.
4) Calculation of NPV if Cost of Capital is 13%
Net Present Value = Present Value of Cash Inflows - Initial Investment
= [Annual Cash Inflows*PVAF(13%, 7 yrs)] - $318,000
= ($66,302*4.42261) - $318,000 = -$24,772
Therefore the NPV is negative (i.e. -$24,772).
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