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 here in order to copy the contents of the data table below into a spreadsheet.) Project AProject BInitial investment−$4,646,000$1,553,000*YearOperating cash flows1$562,000$390,0002 915,000 390,0003 1,343,000 390,0004 2,218,000 390,0005 3,405,000 390,000*After-tax cash inflow expected from liquidation. a. If Project A, which requires an initial investment of−$4,646,000,is a replacement for Project B and the$1,553,000initial 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.

Replacement Decisions are the decisions which are taken to replace the old machine with new machine…

Answered: Expansion versus replacement cash flows…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 21P

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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 here

in order to copy the contents of the data table below into a spreadsheet.)

	Project A	Project B
Initial investment	−$4,646,000	$1,553,000*
Year	Operating cash flows
1	$562,000	$390,000
2	915,000	390,000
3	1,343,000	390,000
4	2,218,000	390,000
5	3,405,000	390,000

*After-tax cash inflow expected from liquidation.

a. If Project A, which requires an initial investment of

−$4,646,000,

is a replacement for Project B and the

$1,553,000

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.

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