Question

Your company is considering two projects and has estimated the following cash flows:

Year	Project A	Project B
0	-15,000	-20,000
1	10,000	10,000
2	10,000	18,000

1. If project B expands your manufacturing capacity by building a separate factory, what is the relevant cash flow for evaluating project B in year 2?

2. If project B replaces an existing factory (project A), what is the relevant cash flow for evaluating project B in year 2?

3. If project B replaces an existing factory (project A), what is the relevant cash flow for evaluating project B in year 0?

Answer 1

1. Here, B is an expansion project along with project A, we need to consider the whole cash flow of year 2.
Hence, the relevant cash flow for evaluating project B in year 2 = 18000

2. Here, B replaces project A, hence, we need to apply the incremental cashflow method.
the relevant cash flow for evaluating project B in year 2 = 18000 - 10000 = 8000

3. Here, B replaces project A, hence, we need to apply the incremental cashflow method.
the relevant cash flow for evaluating project B in year 0 = -20000 - (-10000) = -5000

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