Answer to Question #246123 in Management for A .A

Question

Expansion and replacement are. two of. The primary motives for capital expenditure . elaborate on these two motives and on the relevant cash flows associated with each

Answer 1

Expansion is a motive for capital expenditure that entails increasing the productive capacity of the firm, usually through the building or acquisition of major fixed assets. It aims at increasing market share through additional sales capacity. The cash flows associated with expansion motive are the net operating cash flows. These are cash flows generated by the project after the initial outlay has been made and the project is up and running.

Replacement is a motive for capital expenditure that entails replacing existing assets with new or more advanced assets which provide the same function. It is a motive associated with the objective of reducing cost of production rather than enhancing sales. The relevant cash flows associated with replacement are the net operating cash flows and the terminal value cash flows. Terminal value cash flow is the cash flow resulting from liquidation of the project at the end of its forecasted life.