Problem 63 Assume that WalMart Stores Inc has decided to sur

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 12,000 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 $10.75 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 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 Present value of outflows for Bid B s Which bid should be accepted by Wal-Mart. Wal-Mart should accept

Solution

NOTE:

Since the life spans of both the bids are unequal, Equivalent annual cost methodolgy is used.

BID A

Present value of surface cost ($5.5*12000) $66000

Present value of Annual maintenance cost

($0.25*12000*3.23971) $9719

Present value of cash outflows $75719

BID B

Present value of Surface cost ($10.75*12000) $129000

Present value of Annual maintenence cost

($0.09*12000*5.99524) $6475

Present value of cash outflows $135475

  

EQUIVALENT ANNUAL COST

BID A $75719/3.88965 $19466

BID B $135475/6.41765   $21110

Since Equivalent Annual cost is least in case of BID A, hence the same should be accepted

Present value of outflows Bid A	$75719
Present value of outflows Bid B	$135475