Expansion versus replacement cash flows 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.
Project A Project B
Initial investment $40,000 $12,000a
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
a. After-tax cash inflow expected from liquidation.
a. If project A were actually a replacement for project B and 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.