Assume that Future-Mart has decided to surface and maintain for 15 years a vacan

Question

Assume that Future-Mart has decided to surface and maintain for 15 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 8,000 square yards. A surface that costs $8.20 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 19 cents per square yard for each year except the last year of its service. The replacement surface will be similar to the initial surface. A surface that costs $17.10 per square yard to install. This surface has a probable useful life of 15 years and will require annual maintenance in each year except the last year at an estimated cost of 13 cents per square yard. Prepare computations showing which bid should be accepted by Future-Mart. You may assume that the cost of capital is 8%, that the annual maintenance expenditures are incurred at the end of each year, and that prices are not expected to change during the next 15 years.

Explanation / Answer

Initial cost of 8,000 sq. yards X 8.20 per sq yd = $65,600. This cost will be incurred now and at the end of 5 years when the surface is to be replaced. The annual maintenance costs would be incurred in year 1 to 4 and year 6 to 9 and then 11 to 14 years as there is no cost in the last year of service.The annual maintenance cost for the full period would be (8000 sq. yards X 0.19 per sq yd) x12 =1520 X12= $18,240

Bid B - In this the costs are

Initial cost of 8,000 sq. yards X 17.10 per sq yd = $138,600. This cost will be incurred now and at the end of 15 years when the surface is to be replaced. The annual maintenance costs would be incurred in year 1 to 14 as there is no cost in the last year of service.The annual maintenance cost for the full period would be (8000 sq. yards X 0.13 per sq yd) x14 =1040 X14= $14,560

We need to compare the present value of total costs to make the decision. Bid A - In this the costs are

Initial cost of 8,000 sq. yards X 8.20 per sq yd = $65,600. This cost will be incurred now and at the end of 5 years when the surface is to be replaced. The annual maintenance costs would be incurred in year 1 to 4 and year 6 to 9 and then 11 to 14 years as there is no cost in the last year of service.The annual maintenance cost for the full period would be (8000 sq. yards X 0.19 per sq yd) x12 =1520 X12= $18,240

Bid B - In this the costs are

Initial cost of 8,000 sq. yards X 17.10 per sq yd = $138,600. This cost will be incurred now and at the end of 15 years when the surface is to be replaced. The annual maintenance costs would be incurred in year 1 to 14 as there is no cost in the last year of service.The annual maintenance cost for the full period would be (8000 sq. yards X 0.13 per sq yd) x14 =1040 X14= $14,560

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