(2, 2) – Major Programmes and Projects: Contracting Options and Investment Appraisal Techniques Flashcards
What is the ‘client co-ordinated contracting’ approach to management and contracting for projects? What is a benefit and a risk of this approach?
The client organisation will often control the project using a consultant / PM. The client is responsible for the project design and implementation and contractors are used for support. This achieves the best value using competitive tendering and the client can keep control of the project. A risk to this approach is the contractor will lack ownership of the project.
What is EPC?
Engineering, Procurement and Construction Contracts are used by a client to get an EPC Contractor to manage the whole project on their behalf. The two project approaches are:
- Full Turnkey Contracting - apart from specifying their requirements, monitoring progress and making payments the client organisation are not involved. Contractor is responsible for design, engineering, procurement, construction, commissioning, testing and all related activities.
- Partial Turnkey Contracting - same as full turnkey except the client organisation and contractor agree a division of responsibilities.
What is the ‘management contracting’ approach to management and contracting for projects? What is a risk to this approach?
The contractor is selected to manage and co-ordinate the project. They don’t actually carry out the activities, this is done by other contractors. The difficulty with this approach is the management contractor can often find themselves caught between the client and the contractors.
What is a BOOT approach to contracting for projects? What are the 2 key parties in the arrangement?
BOOT (Build, Own, Operate, Transfer) relate back to public sector contracts, where major projects were placed into private hands. The two main parties include:
- Principal - the contracting authority which grants the concession
- Promoter - the organisation which is granted the concession to BOOT the facility
What 4 main packages to BOOT contracts usually consist of?
Construction Package - all areas required for construction e.g. purchase land, site investigations, design, construction, supervision of work, insurances, legal costs
Operational Package - all aspects relating to operating the facility e.g. facilities management services, staff training, consumables, insurances
Financial Package - to meet funding requirements
Revenue Package - activities associated with revenue generation e.g. meeting customer needs and decide on pricing
What is PPP?
Public Private Partnerships are an approach under which private sector organisations take responsibility for public sector service facilities. PPP also provides the public sector with access to skills / knowledge from the private sector.
What is PFI?
Private Finance Initiatives use private money to fund public sector projects.
What are the benefits / pitfalls of PPP (Public Private Partnerships)?
+ Access to funding
+ Access to expertise
+ Supports continuous improvement of public services
+ Risk transfer allocated to the party best able to manage them
- PPP’s often cost too much and exploits the public sector
What are 3 methods for funding investment programs?
Cash within the business
Borrowing from financial institutions
Raised through shareholders
What is the payback analysis or payback period? What is its major drawback?
This is a method for investment appraisal. This technique looks at how long it will take to recoup an investment. If an £800k investment will make £200k per year then its payback period is 4 years. The major drawback is it doesn’t account for the time value of money.
What is ARR? What is its major drawback?
Average Rate of Return is an investment appraisal technique which looks at the future profits to be generated because of the investment.
E.g. if a construction project costs £2m but will generate £2.5m savings over 5 years then the profit is £500k. Over a 5 year period the average annual return is £100k of the £2m investment so 5% ARR.
The drawbacks are is takes no account of time value for money or timings for cash flow. Also estimating profits is subjective.
What is a discounted cash flow technique to investment appraisal?
Used for long term investments where time value of money is important. Discounted cash flow techniques identify the cash flows in and out of a project and note timings. This can then be put into a net annual cash flow and the totals for each year can be discounted to arrive at the net present value (NPV) for the year.
What is NPV? How do you calculate it?
NPV is the net present value. It can be predicted for future amounts. A discount rate is reached based on how difficult it is to raise the finance, the cost of capital, the level of risk involved and the impact of inflation. If there is a discount rate of 7% then each year will have a factor, year 0 = 1.00, year 1 = 0.935, year 2 = 0.873… If the net cash flows of £285k after year 1 then 285k * 0.935 = £266k
What are the strengths and weaknesses of discounted cash flow?
+ recognised as detailed investment appraisal technique
+ takes into account the timings of cash flows and consider the time value of money
+ considers the cost of funding
- Calculations are based on subjective assumptions (predicting cash-flows)
- Can be complex on large / long term programmes
- Determining a discount rate can be a challenge
What is IRR? What are the drawbacks?
Internal Rate of Return is a method for investment appraisal. IRR is the discount rate that when applied to future cash flows makes them equal to the outlay. IRR is the yield on the investment. The criticism of this is that it doesn’t take into account the size of the investment so a lower yield on a higher investment might create greater benefit.
