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 table below.

a. If project A were actually a replacement for project B and if the $12,600 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.

5,700

Calculate relevant Cash flows for this replacement decision:

Project A Project B Initial investment $40,300 $12,600 Year Operating cash flows 1 $10,900 $5,700 2 11,200 5,700 3 13,700 5,700 4 15,500 5,700 5 10,100

5,700

Explanation / Answer

a. If the $12,600 initial investment shown for project B were the after-tax cash inflow expected from liquidating it, only the incremental initial cost should be considered and the also the incremental revenue should be used for calculation. Hence, the relevent cash flows will be as under:

b. This expansion decision will be viewed as a special form of replacement decision when incremental benefits are expected from almost the same know-how and process. If System B is already in place and System A is to be brought in place of System B, then it will be viewed as a replacement decisio. Otherwise, both would have been considered seperately

Year Relevant Cash Flows 0 -27,700 1 5,200 2 5500 3 8000 4 9800 5 4400

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