Omega Constructions plc, a large construction company, has been invited by the Greater Manchester Authority (GMA) to bid via a tender contract, for major ground preparation work on an old disused industrial site, to make way for a new public gardens and wetlands.

Senior management is very much aware that this will be a very competitive bidding process and it was agreed that a total tender price of 18.5 million for the GMA contract would be reasonable. The Financial Director of Omega Construction plc has asked you to advise management whether the proposed bid will enhance shareholder value. If there is a danger of being outbid, a lower price would be considered as long as the figures add up.

The work will take 5 years to complete and would commence 1^st January 2023. The successful bidder of the contract would receive an advance payment of 5 million at the start of the contract, 5 million receivable at the end of year 2, with the balance receivable at the end of the contract (ignore inflation).

You have the following information and estimates for the GMA contract work:-

Materials to be used on the ground preparation work are estimated to cost 850,000 p.a. for the first two years, 1,250,000 p.a. for the next two years and 700,000 in the final year.

Omega Construction plcs entire workforce is highly skilled in environmental engineering and the company uses external labour for the bulk of low skilled construction work. The GMA contract will require the company to transfer twenty of its skilled employees from existing projects for the last 18 months of the contract. The current annual wage for each of these employees is 28,000, but they will be offered a premium of 15% for working on the GMA contract. The company will of course need to replace these employees by new workers, who will be paid a comparatively lower wage of 25,000 p.a. due to their comparative lack of experience.

50 lower skilled workers will be hired at a total cost 900,000 p.a. and site management staff at a total cost of 500,000 p.a. will be employed for the duration of the contract.

Fixed costs and overheads are estimated to be 200,000 p.a. which includes a 40,000 allocation of centralised administrative expenses.

Material, labour and overheads are all stated at current price levels (2022) and subject to the annual general rate of inflation.

Specialist machinery costing 3.2 million when purchased in 2019 could be used for the ground preparation work if modified at a total cost of 750,000 payable on 1^st January 2023. The machinery is currently under-utilised and the company had intended to dispose of it at the end of this year for 1.8 million. If, however, the machinery is modified and employed for the entire contract, management estimate scrap proceeds of 500,000 by the end of five years.

Working capital will be required at the beginning of each year equal to 10% of that years material and labour costs and released at the end of the contract.

General Information

1. Omega Construction plc has a financial year end of 31^st December and it is the last quarter of 2022.

2. Machinery, including the modification expenditure attracts capital allowances of 20% reducing balance in the year of expenditure and in every subsequent year of ownership except for the year of disposal.

3. Corporation tax is 19% payable on a current year basis.

4. Unless otherwise stated, assume all cash flows take place at the end of the relevant year and subject to general rate of inflation which is expected to be 2% next year and 3% p.a. in subsequent years.

5. The companys current capital structure consists of 100 million ordinary 10p shares with a current share price of 4.00 paying a constant dividend of 40p per share, and 500,000 zero coupon bonds redeemable in 10 years at par value of 100 and currently trading at 75. Management considers the companys current after-tax weighted average cost of capital as the appropriate rate to assess contract bids.

Assignment Requirements (Total 30 marks)

1. Calculate Omega Construction plcs current after-tax weighted average cost of capital (rounded to nearest whole percentage). (5 marks)

2. Advise senior management, with supporting cash flow and NPV calculations using WACC as the discount rate, whether tendering for the GMA contract at a total price of 18.5 million would enhance shareholder value. (20 marks)

3. Calculate the minimum total contract price that Omega Construction plc should set that would be neutral in terms of shareholder value. (5 marks)

4. Present the above in a report (word document) to senior management.

Extra Guidance

WACC calculation

• For cost of equity - use formula on page 158 where g = 0 i.e. constant dividend with no growth
• For cost of zero bonds use formula on page 156.
• WACC calculation use formula on page 160

Time Zones for Appraisal - We are in the last quarter of 2022:-

• 2022 is Year 0 i.e. cashflows occurring at the end of 2022 or beginning of 2023
• 2023 is Year 1 i.e. cashflows occurring at the end of 2023 or beginning of 2024

2024 is Year 2 i.e. cashflows occurring at the end of 2024 or beginning of 2025, and so on