Question

Expansion versus replacement cash flows   Tesla 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	−$4,652,000	$1,543,000​*
Year	Operating cash flows
1	$556,000	$371,000
2	925,000	371,000
3	1,359,000	371,000
4	2,224,000	371,000
5	3,400,000	371,000

​*After-tax cash inflow expected from liquidation.

a. If Project​ A, which requires an initial investment of −$4,652,000​, is a replacement for Project B and the $1,543,000 initial investment shown for Project B is the​ after-tax cash inflow expected from liquidating​ it, what would be the net 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.

Answer 1

a		Project A	Project B	Net Cash flows
	Initial investment	$(4,652,000.00)	$ 1,543,000.00	$    (3,109,000.00)
	Year	Operating cash flows
	1	$    556,000.00	$371,000	$185,000
	2	$    925,000.00	$371,000	$554,000
	3	$ 1,359,000.00	$371,000	$988,000
	4	$ 2,224,000.00	$371,000	$1,853,000
	5	$ 3,400,000.00	$371,000	$3,029,000
	Net cash flows for this replacement​ decision			$3,500,000
b	Expansion decision such as project A be is a special form of a replacement​ decision.
	In replacement decision, a project is generally replaced with another project of generally same size
	However a expansion project is a replacement of existing project with another project of significantly higher investment