You work for ConstCo, a medium-sized engineering and construction company with annual profits of about $100 million. You recently entered as a contractor into a bidding process for a large construction project. The total (projected) cost for the project will be about $500 million. The project will have a duration of 5 years, and the following estimated cost will occur throughout the five years (assume all cash flows occur at the end of a year):

Year 1: $200 million

Year 2: $100 million

Year 3: $100 million

Year 4: $50 million

Year 5: $50 million

Part A: The project is auctioned on a lump-sum turnkey contract, i.e. you as the contractor will receive a fixed payment for the project. Your sales manager is convinced that you can win the bidding process for a bid of about $650 million, with 20% being paid after the first year, 10% after years 2-4, and the final 50% being paid upon completion. Your finance department suggests using an interest rate of 15% for this project, since it represents considerable risks, like your client defaulting or actual costs being very different from your estimates. Calculate the Net Present Value for this project (see attached solution to part A).

Part B: Upon successfully bidding for the project (and obtaining the conditions specified in Part A), your client approaches you with an alternative arrangement. Instead of a lump-sum turnkey contract, they are willing to convert the project to a regular Engineering and Construction contract, where you bill the client for your cost. To align incentives, the client proposes that to ensure your profitability, they give you a 10% stake in the company that controls the project (called ManCo), a company that basically oversees construction, manages the facility afterwards and distributes the profits from the project to its owners. ManCo's CFO sees the current NPV of the project at $300 million, so your 10% stake of that would be worth $30 million. Your auditors have checked this estimate and consider it a fair value. But your auditors also warn you that there is considerable risk in this value - at the end of the project, ManCo may be worth as little at 10, or as much as 600 million dollars. Cost variations are a key reason for this risk. They expect that the probability distribution of the value of your stake in ManCo is a uniform one (i.e. equal probabilities) over all possible values from $1 to $60 million.

After some negotiations, your CEO is able to obtain a guarantee from ManCo that you can convert this 10% stake at any time for a $20 million lump-sum payout. For simplicity, assume that you would find out very quickly after signing the contract (i.e. within the first year) what the final value of your stake is.

Evaluate this alternative contract from a financial perspective. Should you consider this alternative contract? Besides your financial considerations, feel free to comment on other advantages and disadvantages you can see in this contract, and write a short (not more than half page) recommendation to your management team at ConstCo.

Must complete all steps:

Question	Grading Criteria	Points
A1	Successfully calculate the correct series of Cash Flow	10
A2	Have the correct discount factor analysis	10
A3	Successfully calculate the correct amount of Present Value (PVs)	10
A4	Get the correct project NPV	10
	Subtotal	40
B1	Successfully calculate the correct series of Cash Flow	20
B2	Consider the project probability into the eNPV calculation	10
B3	Successfully calculate the correct Expected Value (EV)	10
B4	Successfully calculate the correct NPV	10
B5	Defend recommendation arguments	10
	Subtotal	60
	TOTAL	100

Part A Solution: please crosscheck

Year FCF Outflow FCF Inflow Net FCF Discount Factor PV Supporting Data 200 130 -70 0.87 -60.87 Bid Amount 650 2 100 65 -35 0.76 -26.47 % paid year 1 0.2 3 100 65 -35 0.66 -23.01 % paid year 2-4 0.1 4 50 65 15 0.57 8.5763 % paid year 5 0.5 5 50 325 275 0.50 136.72 Interest Rate 0.15 NPV of Project 34.95