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NCR ACCESS ROADS1

PANCRACIO INUPAKAN, the financial manager of LUMUNDOT CIVIL WORKS, INC., a domestic

civil engineering company, reread the recently received email. He was delighted that the nearly endless conversations with the departments of transportation and of public works and highways were finally coming to a close.

LUMUNDOT CIVIL WORKS has been selected as the prime contractor for a P1.68 billion project that involved the reconstruction and upgrading of the intermediate highway network linking the provinces north, south, east and west of Luzon to the National Capital Region (NCR). The NCR access roads project was indicative of the types of projects on which LUMUNDOT had established its reputation, both domestically and internationally, for being a leading construction contractor. The total cost of the project was estimated at P1.46 billion, so the P1.68 billion value provided only a 15 percent return, which was, unfortunately, below the 18 percent hurdle rate required by LUMUNDOT for projects of this nature. On the other hand, the less-than-desired returns seemed a small cost to pay to maintain a steady flow of new projects during these slow economic times.

The email requested from LUMUNDOT a response to the project proposal within a week. The wording of the contract would then be finalized in the subsequent weeks, and the contract signed by mid of the next quarter.

THE PROJECT

The terms of the proposed contract contained several provisions:

The departments would advance to LUMUNDOT at the signing of the contract 15 percent of the total value.

If work progressed on schedule, LUMUNDOT could bill the departments as milestones were reached in accordance with the following schedule:

YR01 P 110,000,000

YR02 430,000,000

YR03 480,000,000

YR04 390,000,000

YR05 270,000,000

The departments would pay 80 percent of each bill received. Payment, of course, would be subject to a satisfactory inspection of the site by the departments’ engineers. The 20 percent deduction would be withheld for (a) the recovery of the advance payment (15 percent) and (b) the accumulation of a retention fund (five percent).

Half of the retention would be reimbursed at the time of completion (end of YR05). The second half would be repaid at the end of YR06, provided the roads did not show any flaws in their first year of use.

During the past several months, the LUMUNDOT engineering department had inspected the sites, confirmed the surveys, and reviewed the drawings that had been provided by the departments. In the opinion of the vice president of engineering, the project presented “no unusual challenges.” It was similar to several LUMUNDOT projects in other parts of the country and abroad that were now nearly complete and that had moved ahead without difficulty.

For LUMUNDOT to proceed, equipment would have to be ordered immediately so it would be available in the fourth quarter of YR01 when earth-moving would commence. The cost of the equipment would be P380 million with 75.0% due upon order and the balance due upon delivery. At the end of the project, the equipment would have no salvage value. The engineering department estimated that the cost of completing the project (not including the equipment) would be P1.08 billion. P70 million would be expended in YR01 for preliminary site work. The project would then proceed at estimated costs of P280 million, P310 million, P250 million and P170 million for the subsequent years.

The project would be managed by one of LUMUNDOT’S experienced project managers, CANUDO TABOGOK. TABOGOK had just completed a major waterworks project in the Cordillera Autonomous Region and was noted for strong engineering skills and tight cost control.

LUMUNDOT’S profits are subject to corporate income tax of 30 percent.

REQUIRED:

1. Analyze the case facts and the proposal thoroughly. As LUMUNDOT’S consultants, you are mulling over the possibility of sourcing the bulk of the funds required to undertake the project from a bank.

2. To ensure that LUMUNDOT gets the required funding from the bank, you would like to do your own independent projections as a means to validate MR. INUPAKAN’S numbers.

3. What are the possible risks the project faces that you feel are critical and must be addressed to convince the bank to fund the project?

4. In light of MR. INUPAKAN’S statement: “the less-than-desired returns seemed a small cost to pay to maintain a steady flow of new projects during these slow economic times,” should LUMUNDOT accept the contract in the first place?

5. Consider now the results of your projections in #2 above, and your answers to #s 3 and 4, is this a viable project to undertake?