Edison Systems has estimated the cash flows over the 5-year lives for two projec

Question

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 following table. a. If project A were actually a replacement for project B and if the $12,000 initial investment shown for project B were the after-tax cash inflow expected from liquidating it, 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 of a replacement decision? Explain. Project A Project B Initial Investment $40,000 12000* Year Operating Cash inflows 1 $10,000 $6,000 2 12,000 6,000 3 14,000 6,000 4 16,000 6,000 5 10,000 6,000 *After-tax cash inflow expected from liquidation.

Explanation / Answer

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 following table. a. If project A were actually a replacement for project B and if the $12,000 initial investment shown for project B were the after-tax cash inflow expected from liquidating it, 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 of a replacement decision? Explain. Project A Project B Initial Investment $40,000 12000* Year

Operating Cash inflows

1                $10,000     $6,000

2                12,000        6,000

3             14,000         6,000

4               16,000         6,000

5             10,000      6,000

=               $22,000           $18,000

*After-tax cash inflow expected from liquidation

if there is no discount rate:
A: -$40,000(investment) +10,000+12,000+14,000+16,000+10,000 = $22,000
B: -$12,000(investment) + $6,000 + 6,000 + 6,000 +6000 + 6,000 = $18,000

accept both projects because the cash flows from both project are positive.



If the projects are mutually exclusive

choose project A.

If project A was a replacement for project B, the relevant cash flows for the replacement decision would only include the cash flows from Project B because the $12,000 cash flow

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