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

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 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 0 decimal places, e.g. 458,581.) Present value of outflows for Bid A

Explanation / Answer

The following calculations in the table are done for to calculate the outflows in the case of Bid A

The cost of capital is 9%.

Since the payments are done at the end of the year, the Present value is calculated for Installation Cost and Annual maintenance as below.

Present Value of $62500 at the end of 5 years: 62500/(1+0.09)^5 where 0.09=Cost of Capital

Similarly, PV of Annual Maintenance at the end of each year = (2825/(1+0.09)^Discount Factor) where Discount Factor is the value when multiplied with the future cash flow gives the present value.

Discount Factor would be 2 if the payment is done at the end of 2 years

Bid A Parking Area(Sq Yards) 11300 Cost of Capital 9% Per Square Yard Total Cost of Surface Installation Cost $ 5.50 $ 62,150.00 Annual maintenance $ 0.25 $ 2,825.00 Years 0 1 2 3 4 5 6 7 8 9 10 Total Installation Cost $ (62,150.00) $ (62,150.00) $     (124,300.00) PV of Installation Cost $ (62,150.00) $ (40,393.24) $     (102,543.24) Annual Maintenance $                      (2,825.00) $ (2,825.00) $ (2,825.00) $       (2,825.00) $                    -   $    (2,825.00) $   (2,825.00) $ (2,825.00) $ (2,825.00) $                -   $       (22,600.00) PV of Installation Cost 2591.743119 2377.74598 2181.41833 2001.301221 0 1684.455198 1545.371742 1417.77224 1300.708477 0 $         15,100.52 Discount Factor 1 2 3 4 5 6 7 8 9 10 Total PV of Outflow for Bid A(Annual Maintenance+Installation Cost) $ (87,442.72)

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