Could someone help me with this problem, and help explain how to get the correct
ID: 2548383 • Letter: C
Question
Could someone help me with this problem, and help explain how to get the correct answer?
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 11,500 square yards Bid A: A surface that costs $5.75 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 $10.50 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 11 cents per square yard Compute present value of the bids. You may assu me that the cost o capital is 11%, that the annual maintenance expenditures are incurred at the end o each year, and that prices are not expe ed to change dur g the next 10 years. Round factor values to 5 Present value of outflows for BidA Present value of outflows for Bid B decimal places, e.g. 1.25124 and final answer to o decimal places, e.g. 458,581.) Which bid should be accepted by Wal-Mart. Wal-Mart should acceptExplanation / Answer
Solution:
Bid A = Surface cost of $5.75 per square yard for installation at beginning for year and at the end of 5 years. Further annual maintenance cost of 25 cents per square yard for each year except the last year of service.
Therefore Present value of cash outflows:
Bid A:
(11500*$5.75) + (11500*$5.75)*PV factor at 11% for 5th period + (11500*$0.25)* cumulative PV factor for 4 years (1st to 4th period) at 11% + (11500*$0.25)* cumulative PV factor for 4 years (6th to 9th period) at 11%
=$66,125 + ($66,125*0.593451) + ($2,875*3.102445) + ($2,875*1.841151) = $119,579.80
Bid B: Surface cost of $10.50 per square yard for installation at beginning for year for life of 10 years. Annual maintenance cost of 11 cents per square yard for each year except the last year of service.
Therefore Present value of cash outflows:
Bid B:
(11,500*$10.50) + (11,500*$0.11)*cumulative PV factor at 11% for 9 periods
= $120,750 + $1,265 * 5.537048 = $127,754.37
As present value of cash outflows for Bid A is lower than present value of cash outflow for Bid B, therefore Walmart should accept Bid A.