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Assume that Wal-Mart Stores, Inc. has decided to surface and maintain for 10 yea

ID: 2330486 • Letter: A

Question

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 11,300 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.

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.

Which bid should be accepted by Wal-Mart.

Present value of outflows for Bid A $

Present value of outflows for Bid B $

Explanation / Answer

PRESENT VALUE OF CASH FLOWS UNDER BID A

BID A

PRESENT VALUE OF CASH FLOW FOR 11300 SQUARE YARDS

YEAR

RATE PER SQ YARD

CASH OUTFLOW

PV FACTOR

PV OF CASH OUTFLOW

0

5.50

62150

1.0000

62150

1

0.25

2825

0.9091

2568

2

0.25

2825

0.8264

2335

3

0.25

2825

0.7513

2122

4

0.25

2825

0.6830

1930

5

5.50

62150

0.6209

38590

6

0.25

2825

0.5645

1595

7

0.25

2825

0.5132

1450

8

0.25

2825

0.4665

1318

9

0.25

2825

0.4241

1198

10

0.00

0

0.3855

0

TOTAL PRESENT VALUE OF OUT FLOWS

115255

PRESENT VALUE OF CASH FLOWS UNDER BID B

BID B

PRESENT VALUE OF CASH FLOW FOR 11300 SQUARE YARDS

YEAR

RATE PER SQ YARD

CASH OUTFLOW

PV FACTOR

PV OF CASH OUTFLOW

0

10.25

115825

1.0000

115825

1

0.10

1130

0.9091

1027

2

0.10

1130

0.8264

934

3

0.10

1130

0.7513

849

4

0.10

1130

0.6830

772

5

0.10

1130

0.6209

702

6

0.10

1130

0.5645

638

7

0.10

1130

0.5132

580

8

0.10

1130

0.4665

527

9

0.10

1130

0.4241

479

10

0.00

0

0.3855

0

TOTAL PRESENT VALUE OF OUT FLOWS

122333

CONCLUSION -

Present Value of Cash Out Flows Under BID A (i.e. 115255 $) is Less then Present Value of Cash Out Flows Under BID B (i.e. 122333 $). Thus Company Should Select BID A.

NOTES -

1. Year 0 Means Present Day or we Can say Start of the Year 1.

2. In BID A there will be No Maintenance Cost in 5th Year and 10th Year as being last year or its Service.

3. In BID B there will be No Maintenance Cost in 10th Year as being last year or its Service.

4. CASH OUT FLOW

= RATE PER SQ YARD X 11300 SQ YARD

5. PV FACTOR Means Present Value of 1 $ @ 10 % Discounting.

PV Factor = ( 1 / 1.10 )n

(n = No of Year)

6. PV of Cash Out Flow

= Cash Out Flow   X PV Factor

BID A

PRESENT VALUE OF CASH FLOW FOR 11300 SQUARE YARDS

YEAR

RATE PER SQ YARD

CASH OUTFLOW

PV FACTOR

PV OF CASH OUTFLOW

0

5.50

62150

1.0000

62150

1

0.25

2825

0.9091

2568

2

0.25

2825

0.8264

2335

3

0.25

2825

0.7513

2122

4

0.25

2825

0.6830

1930

5

5.50

62150

0.6209

38590

6

0.25

2825

0.5645

1595

7

0.25

2825

0.5132

1450

8

0.25

2825

0.4665

1318

9

0.25

2825

0.4241

1198

10

0.00

0

0.3855

0

TOTAL PRESENT VALUE OF OUT FLOWS

115255

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