Expansion versus replacement cash flows Edison Systems has estimated the cash flows over the 5-year

QUESTION

Expansion versus replacement cash flows Edison Systems has estimated the cash flows over the 5-year lives for two projects, A and B. These cash flows are summarized in the table below.a. If project A were actually a replacement for project B and if the $12,000 initialinvestment shown for project B were the after-tax cash inflow expected from liquidatingit, what would be the relevant cash flows for this replacement decision?b. How can an expansion decision such as project A be viewed as a special form ofa replacement decision? Explain.Project AProject BInitial investment$40,000$12,000aYearOperating cash inflows12345$10,000 12,000 14,000 16,000 10,000$ 6,000 6,000 6,000 6,000 6,000A After-tax cash inflow expected from liquidation.
Project A 0 1 2 3 4 5 Initial Investment -40,000 After tax inflows 10,000 12000 14000 16000 10000 NPV 22,000 Project B 0 1 2 3 4 5 Initial Investment -12,000 After tax inflows 6,000 6,000 6,000 6,000 6,000 NPV 18,000 (a)if Project A were the replacement of project B then $12000 will not be there as initial investment instead a division would be liquidated and further $12000 would be generated therefore the NPV of Project A would have been $22000+$12000= $34000 (b)If this expansion takes place then obviously as a division project A

uld be benefited as the NPV would rise from $22000 to $34000 but then the combined NPV would not be benefited as it would fall from $40000 ($22000 + $18000) to $34000, so in all a replacement decision might be beneficial for the division but not for the company. In both the scenarios we have ignored the time value of money so not used any discounting rates.

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