Question

Problem 6-3 Assume that Wal-Mart Stores, Inc. has decided to surface and maintain for 10 years a vacant lot next to one of its stores to serve as a parking lot for customers. Management is considering the following bids involving two different qualities of surfacing for a parking area of 11,600 square yards. Bid A: A surface that costs $5.75 per square yard to install. This surface will have to be replaced at the end of 5 years. The annual maintenance cost on this surface is estimated at 25 cents per square yard for each year except the last year of its service. The replacement surface will be similar to the initial surface. Bid B: A surface that costs $10.00 per square yard to install. This surface has a probable useful life of 10 years and will require annual maintenance in each year except the last year, at an estimated cost of 9 cents per square yard. Click here to view factor tables Compute present value of the bids. You may assume that the cost of capital is 9%, that the annual maintenance expenditures are incurred at the end of each year, and that prices are not expected to change during the next 10 years. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to o decimal places, e.g. 458,581.) Present value of outflows for Bid At Present value of outflows for Bid Bt Which bid should be accepted by Wal-Mart. Wal-Mart should accept Click if you would like to show Work for this question: Open Show Work

Answer 1

Calculation of Present Value of Bid A.

Present value of initial cost = 11,600 * $5.75 = $66,700

Present value of maintenance cost (years 1–4) = 11,600 * $0.25 = $2,900
= $2,900 * PVAF 9% 4 years = $2,900 * (3.23972) = $9,395.19

Present value of resurfacing = $66,700 * PVF 9% 5 year
= $66,700 * 0.64993 = $43,350.33

Present value of maintenance cost (years 6–9) = $2,900 * (PVAF 9% 9 years - PVAF 9% 5 years)
= $2,900 * (5.99525 – 3.88965) = $6,106.24

Total Present value of outflows for Bid A = $66,700 + $9395.19 + $43350.33 + $6106.24 = $125,551.76

Calculation of Present value of Bid B.

Present value of initial cost = 11,600 * $10 = $116,000

Present value of maintenance cost (years 1–9) = 11,600 * $0.09 = $1,044
= $1,044 * PVAF 9% 9 years = $1,044 * (5.99525) = $6,259.04

Total Present Value of Outflows of Bid B = $116,000 + $6,259.04 = $122,259.04

Walmart should accept Bid B because the present value of outflows of Bid B is lower.