Case 33

Piping Plus

Background:

Curly, Maureen (Mo to her friends), and Larry founded CML Mechanical Engineers nearly ten years ago. The firm has grown substantially, and it now employs 28 engineers. CML emphasizes industrial and commercial work related to the construction of facilities. For example, they have designed heating and ventilation systems for factories and shopping malls, piping for refineries and chemical plants, and even a treatment facility for oil tanker ballast water. Obviously, they have undertaken many other jobs over the years, but these represent their market niche.

When CML first started business, most of the work was subcontracts for heating and ventilation systems for individual buildings. The jobs are now larger, more complex, and technically far more sophisticated, but CML still generally works as a subcontractor to another design firm. None of the founders, who are still the owners, want to diversify into other branches of engineering or into more general construction or into project management. They enjoy being in close contact with the technical details, even though they do relatively little design work themselves.

Virtually all of the analysis and technical drawings are done with an ever-increasing array of software packages. However, there are beginning to be problems in interfacing with the project management software used by some of their clients. Furthermore, they would like to link the firms accounting and time tracking and billing software with the firms software for design, drawing, and project management.

They believe that this integration will allow automatic tracking of time spent on work Packages, progress on contracts, and billing breakdowns by project type, client, and employee. This will in turn support more accurate estimating for bidding on future work.

It appears that software packages costing about $25,000 initially are needed, and then there would be a 15% annual fee. This fee covers service, answering questions, and periodic updates. Another $30,000 would be needed for a contract with a software integration firm. Initial training of the firms employees is estimated at $12,000, and about one-sixth of that as an annual expense. From looking at their history of software usage, they estimate that the life of this generation of software will be about 5 years.

Curly was assigned the job of estimating the value of having the integrated software, while Mo and Larry examined possible sources of financing. Should the firm get the software? If so, use their three memos and the firm's financial statements to define an acquisition plan. This plan should identify the timing of the purchases and the source of funds for the purchase. What is the rate of return of your proposal?

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Facts:

For this case, we have a 5-year planning horizon.

Use the current status of 4 lost billings and $45,000 lost as Year 0

use the information to project the next 5 years.

If they do not get new software, the lost jobs will increase (a major negative cash flow), and their ability to cover these losses decreases over time.

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Question:

Determine the actual lost revenue for each year.

For instance, in year 1, they would expect to lose 6 jobs. In year 0, 4 jobs lost resulted in $45,000 in lost billings, or lost billings = 45000/4 = $11,250 per job. However, in year 0, 60% of these losses are covered by other jobs, but this ability to cover losses decreases by 10% to 20% each year (use 15% per year as an average).