The Walmart CEO is seeking to expand operations by 10% of its net property, plant and equipment. This project will be compared to Walmart’s assets in 2015. According to Walmart’s balance sheet for the past three years, as shown in the previous presentation, the net property, plant and equipment in 2015 was worth $116,655,000. Therefore, calculations for the cost of new property, plant and equipment to be added in the expansion are 10% of the above amount, or $11,665,500.
Calculations for annual depreciation for the project using the straight-line method are relatively simple. According to project parameters, the salvage value of the new property, plant and equipment will be 5% of the cost, or 5% x $11,665,500, which is $583,275. So we do not depreciate that amount. The depreciable amount is $11,665,500 – $583,275 = $11,082,225. Another way of saying this is that since we will salvage 5% of the cost, we depreciate 95% of the cost, which is $11,082,225.
The project parameters also state that the estimated useful life of the new property, plant and equipment will be 12 years. We therefore divide the total cost that will be depreciated by the total number of years over which the property, plant and equipment will be used. Thus $11,082,225 / 12 = $923,518.75 per year. We now have this calculation of what the new property, plant and equipment will cost the company, spread out over the useful life of the new assets, and can compare this cost with the money that these new assets generate. This will help us make a better decision regarding acceptance or rejection of the project.
We will next determine earnings and free cash flow over the 12-year life of the new property, plant and equipment, followed by other capital budgeting results for the project. These will demonstrate the benefits of the project, and then we will compare them to the above costs to arrive at a decision to accept or reject.