One of the interesting questions to be asked is how much will it cost to add to the existing set-up. They have some PV already as well as batteries , converter and diesel. Is it correct to put the IC for all these components as $0. Leave the replacement costs as it would be normally?  Since they have the existing genset and converter there, i would not plan to increase their size. The only problem i can see is if the battery number needs to be increased. If the IC is set to $0, then will all increases in battery cost not be counted?

Yes, for any existing component you should use zero capital cost and normal replacement cost.  If there are presently 12 batteries in the battery bank, and batteries cost $100 each, then you should indicate zero capital cost for 12 batteries, and $100 for 13 batteries.  That way HOMER can see that it costs nothing to stay at 12 batteries, but it can explore whether expanding the battery bank is worth the cost. 

The only problem is that HOMER won't let you say the existing component will last for N more years, but the replacement component will last for some other number of years.  Otherwise this approach works just fine.