lecture 19 revision

8/7/2019 Lecture 19 Revision

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Whitewater LimitedConsulting Engineers & Scientists

FINANCIAL ASPECTS OF PROJECT ENGINEERING AND

CONTRACTINGPROJECT APPRAISAL FOR BIOPROCESS

Richard Hill

REVISION


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2008 Question 1

VALUE P & L B S1st stage payment received 10% 4.8m Turnover Does not appear2nd stage payment received 20% 9.6m Turnover Does not appear

Payment against work completed is total 50%, that is 24mWork completed is 75% of this 24m = 18m (37.5%) This is in 9 months (April Dec) so 2m per

month.8 months work (16m) will be invoiced and paid but the December invoice (2m) will not yet havebeen paid hence:3rd stage payment received 33%

16.0m Turnover Does not appear

3rd stage payment invoice 4.2% 2.0m Turnover Current Assets (Debtors)Materials invoice 12m Cost of Sales Current liabilities (Creditors)Site equipment 8 months at

15,000

120k Cost of Sales Does not appear

Site equipment 1 month (Dec)

15k Cost of Sales Current liabilities (Creditors)

Claim Does not appear Does not appearBalance of contract value 33% 15.6m Does not appear Current Assets (WIP)


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2008 Question 5

Very briefly define Turnover

ontribution

Overheads

Profit [4 marks]

These four items makeup theoutlineof a years business plan.

Assumingthat all sales yield the same percentage contribution, drawa graph showingthe relationship of the last threeof these itemsagainst turnover. On it, show a years planned work and profit, andthe breakevenpoint, with some typicalnumbers [6 marks]

With reference to thegraph, very briefly describe Over-tradingand

its consequences [6 marks] Briefly describe Marginal elling, its uses and limitations [4 marks]


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2008 Question 5 a

Turnover is the total sales for the year (total invoiced)

ontributionof a contract is the contract price minus the direct costs

Overheads are costs which cannot be attributed to individual contracts

Profit is Turnover - (Direct osts + Overheads),or ontribution Overheads


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2008 Question 5b

PLANNED

PROFIT

A

B

C

0

0.5

1

1.5

2

2.5

3

3.5

0 2 4 6 8 10 12

Turnover m

Contrib

ution OVERHEADS


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2008 Question 5c

Overtradingis the resultof committing the company to producing more than itis capableof performing, and in particular more than the companys workingcapital can support. ( howongraph)

The temptation toovertrade lies in the fact that thegraph seems to show thatexceedingthe planned turnover results in sharply increased profitability. In factit will probablynot do so. Thegraph is basedon the assumption that the

overheads are fixed (I.e. independentof the turnover) This is only true for smallchanges in turnover. xceedingthe planned turnover will result in increasedoverheads which willeatup someor allof the increased profit which thegraphappears to promise.

Since the companys plan should have committed the company to produce asmuch as its limitations allow,overtradingmeans oversteppingoneor moreofthese limitations. The problems which arise dependon which of the companyslimitations is beingexceeded:

* xceedingthe companys capacity for work,or its technical capability, will leadto delay andexpensive mistakes.

* If the companys workingcapital cannot sustain the increased demand, thecompany may become insolvent. This can happeneven while the company isapparently tradingprofitably.


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2008 Question 5d

MarginalSelling is usefulonly when a company has unused capability.When that is the case, the company can lower its contribution below the

planned level, in the hope that the reduced sellingprice will bring inextrawork to takeup the slack. Any sales made in this way willnot bring in the

planned contribution, but they will bring in some, which is better thannone.

Marginal sellingcan apply to the whole company if it does not achieve itsplannedoutput,or to parts of the company which happen to beunder-employed.


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2009 Question 1

Define and brieflyexplain the following:

a) Profit Margin [1 rk]

b) ReturnonShareholders apital[1 rk]

c) urrent ratio [1 rk] d) Liquid ratio [1 rk]

The 2008 published Profit and Loss Account and Balance

Sheet for WessexWater plc, whose principal business is

drinkingwater supply, are setout below. Foreach year

calculate the values foreach of the above parameters andcommenton how and why they differ from typical values for the

contractingindustry. [16 rks]


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2009 Question 1

PROFIT AND LOSS ACCOUNT 31 MARCH 2008

2008 2007

m m

Turnover 394.4 366.8Operating costs (200.5) (199.7)

Operating profit 193 .9 167. 1

Interest (payable) (88.9) (72.0)

Interest receivable 18.4 7.4

Other finance income / (costs) 1.1 (0.4)

Profit on ordinary activities before taxation 124.5 102.1

Taxation on profit on ordinary activities (29.0) (12.2)Profit attributable to shareholders 95.5 89.9


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2009 Question 1BALANCE SHEET 31 MARCH 2008

2008 2007

m m

Fixed assetsTangi l ass ts 1,891.2 1,750.5

Investments - -

1,891.2 1,750.5

Current assetsSt kand workin progress 4.3 4.3

Debtors 116.9 104.5

Cas at bankand in hand 290.0 255.0

411 .2 363.8

Creditors amounts falling due within one year (468.4) (127.0)

Net current (liabilities) / assets (57.2) 236.8

Total assets less current liabilities 1,834.0 1,987.3

Creditors amounts falling due after more than oneyear

(1,380.7) (1,548.2)

Provisions forliabilities and charges (86.4) (88.1)

Net assets 366.9 351.0

Capital and reservesCalled up equity share capital 81.3 81.3

Profit and loss account 285.6 269.7

Equity shareholders funds 366.9 351.0


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2009 Question 1a

a)Profit Margin (Operating Profit + I terest Receivable)/(Tur over) [1 mark]

2008 2007Operating profit fromP&L a 193.9 167.1Net I terest received fromP&L b -70.5 -64.6

Tur overfromP&L c 394.4 366.8Profit margin = 100 x (a + b)/c 31.3% 27.9%

These profit marginsare typical foracapital-inte sive business li ewatersupply a d are very high by

comparison with thecontracting industry. [4 mark ]

b)Retur on Shareholdersfunds(Operating Profit + I terest Receivable)/(Capital &Reserves)

[1 mark]

apital a d ReservesfromBala ceSheet d 366.9 351.0

Retur = 100 x (a + b)/d 33.6% 29.2%

Shareholders Capital is thecapital a d reserves(theshareholdersassets). This is highertha wouldnormally be found in a capital inte sive business a d similar to what would be expected in the

contracting industry where(a) thefixed assetsare lowera d (b) theriskismuch higher.[4 mark ]

c) urre t Ratio (Curre t Assets)/(Curre t Liabilities) [1 mark]


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2009 Question 1c

b) Return on Shareholdersfunds (Operating Profit Interest Receivable)/(Capital & Reserves)

[1 ark]

Capital and Reserves from Balance Sheet d 366.9 351.0Return 100 x (a b)/d 33.6 29.2

Sha hold apital is the capital and reserves (the shareholders assets). This is higherthan wouldnormally be found in a capital intensive business and similar to what would be expected in thecontracting industry where (a) the fixed assets are lowerand (b) the riskis much higher. [4 arks]

c) Current Ratio (Current Assets)/(Current Liabilities) [1 ark]

Current assets from Balance Sheet e 411.2 363.8

Current liabilities from Balance Sheet f 468.4 127.0Current ratio e/f 0.88 2.86

The Current Ratio is an indicatorofthe companys financial health since a Current Ratio greaterthan 1means the company is solvent and a Current Ratio ofaround 1.5 indicates sufficient working capital. Ifthe Current Ratio exceeds about 2 it is indicative that there is too much working capital and that loansshould be reduced. The Wessex Current Ratios indicate a company with low liquidity (although its high

fixed assets means that it is farfrom insolvent). [4 arks]

d) Liquid Ratio (Current Assets Stocks)/(Current Liabilities) [1 ark]

Stocks from Balance Sheet g 4.3 4.3Liquid ratio (e-g)/f 0.87 2.8

The Liquid Ratio also called the acid t t is the ratio ofthe liquid a t to current liabilities. Theliquid assets are those which can be drawn upon immediately without the need to sell stock or in thecase ofa contractor to complete current contracts. Ifthe Liquid Ratio is less than 1, as is the case with

C i /f 0 88 2 86


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2009 Question 1d

Current ratio = e/f 0.88 2.86

The Current Ratio is an indicator of the companys financial health since a Current Ratio greater than 1means the company issolvent and a Current Ratio of around 1.5 indicatessufficient working capital. If

the Current Ratio exceeds about 2 it is indicative that there is too much working capital and that loansshould be reduced. The essex Current Ratios indicate a company with low liquidity (although its highfixed assets means that it is far from insolvent). [4 ark

d) Liquid Ratio (Current Assets Stocks)/(Current Liabilities) [1 ark

Stocks from Balance Sheet g 4.3 4.3

Liquid ratio = (e-g)/f 0.87 2.8

The Liquid Ratio also called the acid tst is the ratio of the liquid ass ts to current liabilities. Theliquid assets are those which can be drawn upon immediately without the need to sell stock or, in thecase of a contractor, to complete current contracts. If the Liquid Ratio is less than 1, as is the case with

the essex 2008 accounts, the liquid assets are insufficient to meet current liabilitiesso the companywould be unable to meet its debts without realising some of its fixed assets. The change in liquidityfrom 2007 to 2008 is the result of a large increase in creditors in 2008 probably due to capital

investment for which the contractor has not yet been paid. Typically a Liquid Ratio of around 0.75 isregarded as adequate but utility companies, because of their unique position, can afford to have low

liquidity. [4 ark


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2009 Question 3

In month 1of the present financial year acontractor was awarded a contract to design,supply, deliver, install and commission a

pharmaceutical manufacturing facility valued at

300m.Terms of payment are

10% with order

20% on approvalof drawings

50% on completionof installation

10% on commissioningand10% retention for12 months.


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2009 Question 3

During the present financial year: (a) The contractors drawings were approved in Month 4.

(b) The contractor completed installation and invoiced inMonth 11 with payment due 3 months later.

(c) ommissioningis scheduled to be completed and

invoiced 3 months after completionof installation. (d) The contractor has received invoices from all the

materials suppliers and subcontractors totalling225m forwhich settlement is due in 30 days after theendof thecurrent financial year.

(e ) The contractor has submitted a claim to the lient for

extras valued at 15m.How will these items appear in: (i) The BalanceSheet[10 rks] (ii) The Profit Loss Account [10 rks]


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2009 Question 4

Briefly define:

(a) Turnover [1 rk]

(b) Direct costs [1 rk]

(c) ontribution [1 rk] (d) Profit [1 rk]

(e) Breakeven [1 rk]


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2009 Question 4

You are the hief xecutive Officerof a contractingcompany in the chemical

process plant sector. In 2008 your turnover was 150m and the Profit and

Loss account showed:'

,t l ,

G it ,

t ti t ,

ti it ,

t i it t ,t i it i ,


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2009 Question 4

As a resultof theglobaleconomic situation, youanticipate a downturn in the market for 2009 byas much as 40%. (f) At the 2008 levelof contribution andoverhead

costs, what turnover would youneed to achievebreakeven in 2009? [4 rks]

(g) If your turnover were to drop by 40% how wouldthis affect your projected profit for 2009 assumingcontribution andoverheads remain at the 2008 values?

[4 rks] (h) What steps might you consider taking inorder to

reduce the impactof the reduced turnover? [7 rks]


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2009 Question 4

(a) Turnover is the companys output in the year,measured by the total invoiced. [1 mark]

(b) Direct osts are costs directly attributable to identifiedcontracts. [1 mark]

(c) ontribution is the valueof a contract minus its directcosts; it is the sum of money that a contract contributes tothe companys overheads and profitor "Gross Profit".[1 mark]

(d) Profit is the sum left after all companys costs in theyear have been deducted from all theearnings. [1 mark]

(e) Breakeven is the turnover thatjust covers thecompanys direct costs andoverheads leavingnonetprofit. [1 mark]


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2009 Question 4

2008 2009 2009 2009

actual Scenario 1 Scenario 2 Scenario 3

000 000 000 000

breakeven 40 downturn educed overheads

Turnover 150,000 120,000 90,000 90,000ost ofsales 105,000 84,000 63,000 63,000

ost ofsales 70.0 70.0 70.0 70.0

ross profit 45,000 36,000 27,000 27,000

ontribution 30.0 30.0 30.0 30.0

Net operating costs 36,000 36,000 36,000 27,000

Operating profit 9,000 0 -9,000 0

Operating profit 6.0 0.0 -10.0 0.0etained profit brought forward 21,300 21,300 21,300 21,300

etained profit carried forward 30,300 21,300 12,300 21,300


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2009 Question 4

(f) Breakeven turnover at 2008 contribution and

overheads 120m [4 marks]

(g) A 40% reduction in turnovergives a 10% loss. [4

marks]

(h) Reduceoverheads to 27m togive breakeven other

options such as marginal selling(but this maynot be

possible if market is depressed), sellengineeringservices

(designonly for future investment) or commissioning

services [7 marks]


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2009 Question 6

(a) What factors contribute to what might be consideredto be a reasonable levelof intereston a bank loan? [5

rks]

(b) The Bankof ngland holds regular meeting to set theBase Rate. What circumstances might make the Bankofngland want to raiseor lower it? [4 rks]

(c) What is LIBOR, how is it set and how does it affectinterest rates on loans to companies? [5 rks]

(d) How do banks actually set the interest rates whichthey chargeon loans to companies? [2 rks]

(e) Why d oes a change in the Base Rate have animmediate impacton someof those who have bankloans? [4 rks] .


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2009 Question 6

(a) The factors are: Base Rate [1 mark]

Security/Risk [ 1 mark]

Admin osts [ 1 mark]

Profit [1 mark] NOT inflation rate - that is included in the Base Rate [1 mark]

(b) The Base Rate indirectly controls the amountofmoney coming into theeconomy. High rates discourageborrowing, and vice versa. If theeconomy is depressedandneeds boosting, the bank can do that by lowering thebase rate, and vice versa. If inflation is seen to be risingtoanundesirable level, the base rate will be raised in thehopeof slowingdownor reversingthe rise. [4 marks]


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2009 Question 6

(c) London Interbank Offered Rate [1 mark] which is therate forunsecured loans between banks [1 mark].

It is set weekly by committeeof British Bankers' Association(BBA) [1 mark].

It is now a better measureof the rate at which banks canborrow money than the base rate so has a greater influenceon interest rates charged by banks [2 marks].

(d) In practice banks charge as high a rate as they can,limited mostly by competition from other banks andlenders [2 marks]

(e) Rates of intereston many loans are set at BaseRate+ x%, and the interest payments on such loansvaries automatically with the Base Rate [4 marks]


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2009 Question 8

(a) The Present Valueof a future sum of Sper

annum is given by:

xplain what the different terms in the formula

mean. [4 rks]

!

ii)(1(1SP

T


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2009 Question 8

(b) You have to install a pumpingstation to deliver1200m3/h ofwater for 70% of the year and 800m3/h for 30% of the year.You havetheoptions of installingthree 600m3/h pumps each 25kWor four400m3/h pumps each 15kW.

In the firstoption, two pumps will run continuously and the flow will bethrottled to meet the 800m3/h duty with no reduction in power

consumption. In the secondoption three pumps will run to meet the1200m3/h duty and two will run to meet the 800m3/h duty.

The 25kW pumps cost 20,000each and the15kW pumps 18,000each.

lectricity costs 10p/kWh. Use an interest rateof 5%pa to calculatethe NPVofeach option so as to identify the lowest costover thefifteen year lifeof the pumpingstation.[16 rks]


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2009 Question 8

(a) In the formula:

PV = present value

S= future value (valueof the incomeor cost per

annum)

i = the interest rateovereach time intervalused

to calculate the NPV.

T = thenumberof years over which the sum

Spa is paid


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2009 Question 8OPTION 1 OPTION 2 Marks

Pump delivery flow m3/h 600 400

Head m 10 10Power kW 25 15 Number installed 3 4Capex per pump 20000 18000Total capex 60000 72000 2Power cost p/kWh 10 10Flow m3/h 1200 1200

Pumps in service No 2 3Power kW 50 45Utilisation at this flow 70% 70%Operation h/year 6132 6132kWh/year 306600 275940Opex /year 30660 27594Flow m3/h 800 800

Pumps in service No 2 2Power kW 50 30Utilisation at this flow 30% 30%Operation h/year 2628 2628

kWh/year 131400 78840Opex /year 13140 7884Total opex /year 43800 35478 6Life years 15 15Interest rate 5% 5%PV of income (= -opex) -454629 -368250 6NPV = Total Capex - PV income 514629 440250 2Hence Option 2 is the lower cost over 15 years and is preferred.


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2009 Question 8

(b) NPV = PVof Future income Investment

NPV = PVofoperatingcost capital cost

NPV Option1 = -454629 90,000 = --544629

NPV Option 2 = -368250 144,000 = -512250

Hence Option 2 is preferred


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2008 Question 2

The UK Base rate is the interest rate which theBankof ngland charges on loans toother banks.

1. What percentage is the UK Base Rate today? [2 M rks]

2. How and why is it changed from time to time? [5 M rks]

3. Companies usually depend in parton bank loans. Whatare the benefits and disadvantages of this? [6 M rks]

4. What is the connection between the Base Rate and theinterest charged by banks on loans to companies?[3 M rks]

5. Why would a bank be likely togive a larger loan to amanufacturingcompany than to a contractingcompanywith a similar turnover? [4 rks]


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2008 Question 2

1. The current base rate is .%. (2)

2. Its level is reviewed and possibly changed monthly (1) by acommittee (1) of the Bank of England (1). If the economyneeds stimulating, (1) the committee may decide to reducethe bank rate. This makes it less expensive to borrow money

and so encourages spending and investment. Raising thebank rate has the opposite effect (1).

3. A company borrows money in order to increase the capitalavailable to support its business. (1) If the additionalcontribution which this brings in is greater than the interestpayable on the loan, the companys profit and the return onshareholders capital will increase, (2). Interest on a loan

must be paid whether the company is doing well with it ornot(1). Taking out too large a loan means the interestpayment can ruin a company. (2).


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2008 Question 2

1. Interest on new loans is normally some percentagepoints higher than the Base Rate (1) and some loanspay interest at some fixed percentage above BaseRate, so the it changes automatically whenever the

Base Rate changes (2)2. The typical contractor has few or no fixed capitalassets.(2) If the company fails, therefore, there isnothing left with which the bank can at least recoversome of its loan. (2) By contrast, typical manufacturershave premises, machinery, work in progress and stock.

lecture 19 revision

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