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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) $510,000
Useful life 9 years Salvage value $51,000
Annual net income generated 40,290
BBSâs cost of capital 9%.

Assume straight line depreciation method is used.

Required:
Help BBS evaluate this project by calculating each of the following:

a. Accounting rate of return.
b. Payback period.
c. Net present value (NPV).
d. Recalculate the NPV assuming BBS's cost of capital is 15 percent.

Sagot :

Answer:

a.  0.17556 = 17.56%

b. 5.59 years

NPV when I is 9% = $60,787.91

NPV when I is 15% = $-59,904.72

Explanation:

Accounting rate of return = Average net income / Average book value  

Average book value = (cost of equipment - salvage value) / 2

($510,000 - $51,000) / 2 = $229,500

40,290 /  $229,500 = 0.17556 = 17.56%

Payback calculates the amount of time it takes to recover the amount invested in a project from it cumulative cash flows

Payback period = Amount invested / cash flow

Cash flow = net income + depreciation expense

Straight line depreciation expense = (Cost of asset - Salvage value) / useful life

($510,000 - $51,000) / 9 = $51,000

Cash flow = $51,000 + 40,290 = $91,290

$510,000 / $91,290 = 5.59 years

Net present value is the present value of after-tax cash flows from an investment less the amount invested.  

NPV can be calculated using a financial calculator  

Cash flow in year 0 = $-510,000

Cash flow in year 1 to 8 = $91,290

Cash flow in year 9 = $91,290 + $51,000

NPV when I is 9% = $60,787.91

NPV when I is 15% = $-59,904.72

To find the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.  

3. Press compute  

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