Question

Assume that Walmart 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 cost $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 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 9 cents per square yard. Assume cost of capital is 9%, annual maintenance are incurred at the end of each year and prices are not expected to change during the next 10 years

Answer 1

Solution =

Surface Cost = Cost per square yard * Total square yards.

Annual maintenance cost = Annual maintainence per sqaure yard * Total square yards

Bid A)

Initial cashflow at year 0 = $5.75 × 12000= 69,000 (this repeats after yr 5 also)

Thereafter, annual cashflows in years 1-4 and 6-9 = 12,000 × 0.25 = $3000

So net cost today = 69,000 + 3000/1.09^1 + 3000/1.09^2 + 3000/1.09^3 + 3000/1.09^4 + 69,000/1.09^5 + 3000/1.09^6 + 3000/1.09^7 + 3000/1.09^8 + 3000/1.09^9 = $129881.21

Bid B)

Initial cashflow at year 0 = $10.50 × 12000 = $126000

Thereafter, annual cashflows in years 1-9 = 12,000 × 0.09 = $1080

So net cost today = 126,000 + 1080/1.09^1 + 1080/1.09^2 + 1080/1.09^3 + 1080/1.09^4 + 1080/1.09^5 + 1080/1.09^6 + 1080/1.09^7 + 1080/1.09^8 + 1080/1.09^9 = 132,474.87

As the net cost of bid A is lower than that of bid B, Walmart should choose bid A.

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