Answered Essay: Assume that Wal-Mart Stores, Inc. has decided to surface and maintain for 10 years a vacant lot next to one of

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 11,200 square yards.

Bid A: A surface that costs $5.50 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 $10.25 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 10 cents per square yard.

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Compute present value of the bids. You may assume that the cost of capital is 10%, 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.)

Present value of outflows for Bid A $
Present value of outflows for Bid B $

Which bid should be accepted by Wal-Mart.

Wal-Mart should accept

Expert Answer

 

Present value of both the bids is as calculated below:

Bid A Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total
Amount to be invested (11,200*5.5) ($61,600) ($61,600) ($123,200)
Annual maintenance cost -2,800 -2,800 -2,800 -2,800 -2,800 -2,800 -2,800 -2,800 ($22,400)
Net cash flow ($61,600) ($2,800) ($2,800) ($2,800) ($2,800) ($61,600) ($2,800) ($2,800) ($2,800) ($2,800) $0 ($145,600)
Life 10 years
Rate of Return is 10%
Present Value factor 1 0.90909 0.82645 0.75131 0.68301 0.62092 0.56447 0.51316 0.46651 0.42410 0.38554
Present Value of Net Cash flow -61,600 -2,545 -2,314 -2,104 -1,912 -38,249 -1,581 -1,437 -1,306 -1,187 0 ($114,235)
Bid B Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total
Amount to be invested (11,200*5.5) ($114,800) ($114,800)
Annual maintenance cost -1,120 -1,120 -1,120 -1,120 -1,120 -1,120 -1,120 -1,120 -1,120 ($10,080)
Net cash flow ($114,800) ($1,120) ($1,120) ($1,120) ($1,120) ($1,120) ($1,120) ($1,120) ($1,120) ($1,120) $0 ($124,880)
Life 10 years
Rate of Return is 10%
Present Value factor 1 0.90909 0.82645 0.75131 0.68301 0.62092 0.56447 0.51316 0.46651 0.42410 0.38554
Present Value of Net Cash flow -114,800 -1,018 -926 -841 -765 -695 -632 -575 -522 -475 0 ($121,250)

Walmart should accept Bid A as bid A cost is lower than Bid B cost.

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