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.(Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Project A Project B Initial investment $ 41 comma 000$41,000 $ 12 comma 300$12,300* Year Operating cash flows 1 $ 10 comma 600$10,600 $ 5 comma 200$5,200 2 11 comma 70011,700 5 comma 2005,200 3 14 comma 30014,300 5 comma 2005,200 4 15 comma 50015,500 5 comma 2005,200 5 10 comma 80010,800 5 comma 2005,200 *After-tax cash inflow expected from liquidation. a. If Project A were actually a replacement for Project B and if the $ 12 comma 300$12,300 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. a. Calculate the relevant cash flows for this replacement decision:(Round to the nearest dollar.) Relevant Year Cash Flows 0 $ 1 $ 2 $ 3 $ 4 $ 5 $

Explanation / Answer

a) Given that Project A is a replacement for Project B and Initial investment of Project B i.e. 12300 will be inflow. Therefore, Initial investment will be 41000-12300 = 28700 and the inflows will be Inflow from Project A - Inflow that we are loosing because of replacing Project B. There inflows will be:

Year1 = 10600-5200 = 5400

Year2 = 11700-5200 = 6500

Year3 = 14300-5200 = 9100

Year4 = 15500-5200 = 10300

Year5 = 10800-5200 = 5600

b) It is special form of replacement because not only the initial investment is affected as a result of relacement but also we are taking into consideration the opportunity gain we are going to loose because of replacement.

Year Project A ProjectB 0 -41000 12300 1 10600 5200 2 11700 5200 3 14300 5200 4 15500 5200 5 10800 5200

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