Problem 6-3 Assume that Wal-Mart Stores, Inc. has decided to surface and maintai
ID: 2579993 • Letter: P
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 12,100 square yards.
Bid A: A surface that costs $6.00 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.
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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 0 decimal places, e.g. 458,581.)
Which bid should be accepted by Wal-Mart.
Explanation / Answer
Cost of Capital = 9%
Parking Area = 12,100 Yards
It is mentioned that both Bids will not require any maintenance cost in its last year of Service, so we will not calculate Present value of Cash outflows for that year
(In $)
BID A
BID B
Initial Investment
72,600
($6 per square yard * 12,100 yards)
121,000
($10 per square yard * 12,100 yards)
Useful Life
5 Years
10 Years
Annual Maintenance cost
3,025
($0.25 per square yard * 12,100 Yards)
1,089
($0.09 per square yard * 12,100 Yards)
Present value Annuity Factor (PVAF)
@9% for 4 Years
3.240
@9% for 9 Years
5.995
Present value of outflows for Bid A
= (Annual Cost * PVAF @9% for 4 Years) + Initial cash Outflow
= (3,025 * 3.240) + 72,600
Present value of outflows for Bid A= 82,401
Present value of outflows for Bid B
= (Annual Cost * PVAF @9% for 9 Years) + Initial cash Outflow
= (1,089 * 5.995) + 121,000
Present value of outflows for Bid B = 127,528.55
For Calculating which bid is financially viable, we will have to calculate Equalized amount of Cash outflow each year, for that we will divide the Present value of cash Outflow by the PVAF of Total useful value of that Bid
As I already mentioned that there is no Mant. Cost for last year so we will calculate the outflow for less 1 year as there is no cost in last year but while calculating Equalized amount per year we will take the PVAF for all the years as the Project correct cost will be calculated after taking whole useful life into consideration.
PVAF @9% for 5 Years = 3.890
PVAF @9% for 10 years = 6.418
Bid A = 82,401 / 3.890 = $21,182.776
Bid B = 127,528.55 / 6.418 = $19,870.45
In my Opinion Bid B should be selected as Efficient cash outflow is less than Bid A
BID A
BID B
Initial Investment
72,600
($6 per square yard * 12,100 yards)
121,000
($10 per square yard * 12,100 yards)
Useful Life
5 Years
10 Years
Annual Maintenance cost
3,025
($0.25 per square yard * 12,100 Yards)
1,089
($0.09 per square yard * 12,100 Yards)
Present value Annuity Factor (PVAF)
@9% for 4 Years
3.240
@9% for 9 Years
5.995
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