W8_HPO_Accepting A Project/Contract


1. Problem Statement

Continuing from the previous Blog 6. Determining The Contractor’s IRR in PSC, now contractor must determine whether it should accept the the project/contract or not. Does contractor have to accept the project/contract? Is it economical or uneconomical to contractor?

2. Development of Feasible Alternatives

According to Sullivan, to accepting the economics of a project, we should compare the real IRR earned with the MARR of the project. Contractor should see also the NPV of the project where it should be above zero if we give the hurdle rate of MARR.

3. Development The Outcomes of Each Alternative

In finding the MARR of the project we need to define what MARR is:

Lita Liana (2013) in her CCP paper, defined as: MARR = WACC + Risk Scoring + Country Risk

The assumption of financing and risks related to the project are as below:

  • According to Bank Indonesia data of Corporate Interest Basis is 10.46%. And according to the average of mutual funds return data is 24.13%. The financing the project will be 50% loan and 50% equity. Thus, WACC is equal to 17.30%.
  • The block or operating area of this PSC will be in northwestern shallow offshore are. Operating risk area  of northwestern shallow according to Lita Liana has 3.07% of operating risk.
  • The country risk of Indonesia in January 2013, according to Aswath Damodaran, the latest data of country risk premium is 3%.
  • All calculation here needs excel application because the free cash flows are quite varies.

4. Selection of Acceptable Criteria

We should accept the project if two conditions fulfilled accordingly where (1) IRR > MARR and (2) NPV>0.

5. Analysis of Comparison Between Alternative and Criteria

The total MARR is 17.30%+3.07%+3%=23.37%. The real IRR of contractor result of the previous calculation is 29.12%. Compared to the MARR result, IRR is higher than MARR 29.12% > 23.37%.

From the previous table in blog 6. we calculate the NPV as below:

(in 000 US$)

W8.Fig1

Figure 1.

The NPV of the project shows positive value of US$ 114,743,150.

6. Selection of The Best Alternative

The result of comparation between the IRR and MARR shows IRR > MARR and the result of NPV also shows positive value.

7. Follow Up Assessment

Contractor should proceed the contract because it gives positive value to contractor.

References:

Anonym (2013). Suku Bunga Dasar Kredit. [ONLINE] Available at:http://www.bi.go.id/web/id/Perbankan/Suku+Bunga+Dasar+Kredit/. [Last Accessed 17 November 2013].

Damodaran, Aswath (2013). Country Default Spreads and Risk Premiums January 2013. [ONLINE] Available at:http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html. [Last Accessed 17 November 2013].

J. Erna (2013). 20 reksa dana saham dengan return tertinggi. [ONLINE] Available at: http://ekbis.sindonews.com/read/2013/04/12/32/737333/20-reksa-dana-saham-dengan-return-tertinggi. [Last Accessed 17 November 2013].

Liana, Lita, (2013). Using AHP to Determine Appropriate MARR for Oil and Gas Projects in Indonesia. CCP Certification Technical Paper. 118130 (6), pp.13-17

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). The Time Value of Money. In Engineering Economy (15th ed., pp. 104-162). Upper Saddle River, N.J: Prentice Hall.

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). Evaluating A Single Project . In Engineering Economy (15th ed., pp. 178-222). Upper Saddle River, N.J: Prentice Hall.

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2 Comments

Filed under Hadianto P, Week 08

2 responses to “W8_HPO_Accepting A Project/Contract

  1. OK, still not following the 7 step process but getting closer. The whole idea behind identifying FEASIBLE ALTERATIVES (note it is PLURAL meaning there is more than one) is you are supposed to be looking at more than a single option and deciding which is the better or best.

    SO, if you wanted to get 5 stars for this, you should have turned to page 533 in Engineering Economy, where you will find that the FEASIBLE ALTERNATIVES should have been =>25%; 18% to 24%; 11% to 17% and <10%. Then based on that initial analysis, it would have determined what the hurdle rate was for your project (See Step 4, Figure 1-1, page 7 Engineering Economy)

    One again, PLEASE do not make any further postings until you fully understand and have mastered the 7 step process described on pages 2-15 in Engineering Economy. Follow that step by step process PERFECTLY until you have totally mastered it.

    Again, I promise if you master that process, it will come in handy not only in passing your exams but in your working world as well.

    BR,
    Dr. PDG, Jakarta

  2. Thank You Sir, I’ll fix it. Would you mind to see and rate my blog 6.1 also.

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