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Managerial Accounting

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Using NPV with Different Investments (PDH)

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Paddy Hope Industries is considering three different options for the purchase of a new commercial kitchen for their specialty cake and baking business. The options are as follows:

Option 1 Option 2 Option 3
Initial Investment \$5,000 \$25,000 \$50,000
Annual Cash Flow \$500 \$4,000 \$10,000

Option 1 is to purchase a new oven for \$5,000, resulting in about \$500 in additional cash flows annually due to its more precise temperature system.

Option 2 is also to purchase a new oven, but Option 2 is actually a triple oven that can increase cash flows by \$4,000 per year due to increased production.

Option 3 is to purchase and install an entirely new commercial kitchen, which Paddy has estimated will yield additional cash flows of \$10,000 per year.

If Paddy's hurdle rate is 8% and the cash flows are estimated to occur for seven years, which option should the company choose using Net Present Value calculations?

A

Option 1

B

Option 2

C

Option 3

D

None of the options provide a positive NPV, therefore Paddy should find additional alternatives.