Balloons By Sunset (B8S) is considering the purchase of two new hot air balloons

Question

Balloons By Sunset (B8S) is considering the purchase of two new hot air balloons so that R can expand its desert sunset tours. Various information about the proposed investment folows Intial investment (for two hot air baloons} Useful Iife Salvage value Annual net income generated BBS's cost of capital 397,000 years 55,000 36,127 9% Assume straight ine depreciation method is used Required Help BBS evaluate this project by calculating each of the following: . Accounting rate of return.(Round your answer to 1 decimal place 2 Payback period. (Round your answer to 2 decimal places Years 3. Net present value (NPV), (Future Value of $1. Present Value of S1. Future Value Annuity of 51, Present Value Annuity of 51.)(Use appropriate factoris) 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 (Fubure Value of $1, Present Value of S1, Future Value Annuity of $1, Present Value Annuity of S1.) (Use appropriate factorts) 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) Calculation of Accounting rate of return :

Accounting rate of return = Net income / Initial investment

= $36,127 / $397,000

= 9.1%

2) Calculation of payback period :

Annual depreciation = ($397,000 - $55,000) / 9 Years

= $38,000

Annual cash flow = Net income + Annual depreciation

= $36,127 + $38,000

= $74,127

Payback period = 5 years + ($397,000 - $370,635) / $74,127

= 5 years + $26,365 / $74,127

= 5.36 years

3) Calculation of NPV :

NPV = - Initial investment + Annual cash flow * PVAF@9%,9years + Salvage value * PVF@9%,9th year

= - $397,000 + $74,127 * 5.9952 + $55,000 * 0.46043

= - $397,000 + $444,406 + $25,324

= $72,730

4) Calculation of NPV if Cost of capital is 12% :

NPV = - Initial investment + Annual cash flow * PVAF@12%,9years + Salvage value * PVF@12%,9th year

= - $397,000 + $74,127 * 5.32825 + $55,000 * 0.3606

= - $397,000 + $394,967 + $19,833

= $17,800

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