TOPIC 2 PROJECT INITIATION AND BUDGETING-.pdf

PROJECT INITIATION AND BUDGETING CIVE 4406 CHAPTER 2 1  OUTLINE 1  Contractual arrangements. 2  Phases of a project - scope definition and strategy. 3 Development of project estimates. 4 Economic feasibilit...

PROJECT INITIATION AND BUDGETING CIVE 4406 CHAPTER 2 1  OUTLINE 1  Contractual arrangements. 2  Phases of a project - scope definition and strategy. 3 Development of project estimates. 4 Economic feasibility study. 2  CONTRACTUAL ARRANGEMENT DEFINITION Procurement is the act of obtaining goods or services, typically for business purposes. Procurement is most commonly associated with businesses because companies need to solicit services or purchase goods, usually on a relatively large scale 3  PROCUREMENT SYSTEM IN THE MALAYSIA SEVERAL CONDITION OF PROCUREMENT IN MALAYSIA  Malaysia adapt the procurement system from the British (Jaafar and Aziz, 2006; CIDB, 2009).  In the earlier days, traditional procurement system was practiced by both the public and private sectors to develop their projects.  Beginning from 1990s, Malaysia adopted a new procurement system to cope with the increasing number of project implementation, complexity of building requirement and mega infrastructure projects to support the country’s growth  The new procurement practices which were said to be of ‘fast tracking’ mode are Design and Build (D&B), Built, Operate and Transfer (BOT) and Project Management Consultancy (PMC).  But the statistics from CIDB (2011) reveal that traditional method still dominates the industry with 96.6% and 97.3% usages in years 2009 and 2010 respectively based on total number of projects. 4  PROCUREMENT SYSTEMS IN THE MALAYSIA EXAMPLE OF PHD STUDY ON PROCUREMENT SYSTEM USED IN MALAYSIA Source : Journal of Design and Built Environment Vol.11, Dec 2012 5  PROCUREMENT SYSTEMS IN THE MALAYSIA From the study shows -  Lump Sum-Drawing and specification (LSDS)  The Lump Sum-Firm Bills of Quantities (LSBQ) system  Lump Sum-Approximate BQ’s (LSABQ) system  The Design and Build (D&B) system  Turnkey system is the lowest scorer on the top 5 ‘used’ procurement systems  The data shows that among the respondents (Architects, Quantity Surveyors and Civil Engineers), the use of LSDS, LSBQ and LSABQ, also known as traditional methods, as the main procurement routes are clearly prominent, followed by Turnkey and D&B, categorized under Design & Build method. 6  PROCUREMENT SYSTEMS IN THE MALAYSIA TRADITIONAL MANAGEMENT PROCUREMENT (DESIGN-BID- PROCUMENT BUILD) SYSTEMS PUBLIC PRIVATE DESIGN AND BUILD (D&B) PARTNERSHIP (PPP) 7  Example on common Organization Structure of DBB TRADITIONAL PROCUREMENT (DESIGN-BID- BUILD)  The traditional or conventional procurement method has been a standard practice in the construction industry for 150 years,  Following the emergence of general contracting firms and independent client consultants. Nominate Sub Contractor-under main contractor but appointed by the client 8  TRADITIONAL PROCUREMENT (DESIGN-BID-BUILD) Example on Organization Structure of Architect Consultant 9  TRADITIONAL PROCUREMENT (DESIGN-BID-BUILD)  There are two main features of the traditional method: 1. The design process is separated from the construction. 2. Full documentation (i.e. drawings, work schedules, bills of quantities) must be supplied by the client before the contractor can be invited to tender for carrying out the work.  Therefore client has control over the design through their appointed consultants (i.e. architect). Generally there is no design responsibility on the contractor.  Usually the selected contractor is appointed by competitive tender, but sometimes by negotiation. (LOWEST BIDDER PRICE)  The terms of many traditional contracts that require the client to appoint a professional consultant (i.e. architect, quantity surveyor, contract administrator) to act as an independent contract administrator. 10  TRADITIONAL PROCUREMENT (DESIGN-BID-BUILD)  A traditional lump sum approach in terms of design, quality and cost is relatively low risk procurement option for a client, however the time required for the project overall is likely to be longer than other procurement methods.  WHY?? Because the work is done by following its sequential of activities.  A traditional lump sum contract requires the production of a complete set of documents before tenders are invited. Adequate time must be allowed for this.  There is reasonable certainty on the lump sum cost of the project because the contract figure is usually known at the outset.  The contract does have provision for cost to be adjusted later, if required. 11  DESIGN AND BUILD (D&B)  The Design and Build system was first launched in the Public Works Department by the Malaysia Prime Minister in 1983.  The first project handled by this unit was the Kuala Terengganu Hospital, which was completed in 1985 (Mokhtar 1993).  Design and Build procurement, where a client appoint a contractor (single entity) to initiate project design and complete the construction and commissioning of works.  The process started when a client invite tenders from contractors for getting a design and construct services. 12  DESIGN AND BUILD (D&B)  The close integration of design and construction methods and the relative freedom of the contractor to use their purchasing power and market knowledge most effectively can provide a client with a competitive price.  The client’s requirements might be stated briefly and simply, perhaps little more than a site plan and schedule of accommodation.  On the other hand, they may be a document of several hundred pages with precise specifications.  The contractor’s input also might be restricted to taking a scheme design supplied by the client and developing details and production information.  With a design and construct method, it is possible ensure a quicker start on site, and the close integration of design and construction can result in more effective programming.  Time, however, is needed by the client’s consultants to prepare an adequate set of requirements.  Once a contract is signed, any changes by the client can prove costly. 13  DESIGN AND BUILD (D&B) Example on Organization Structure of Client Consultant 14  DESIGN AND BUILD (D&B) Example on Organization Structure of Client on D&B Contractor Consultant 15  Example on common Organization Structure of Management Contracting MANAGEMENT PROCUMENT SYSTEMS MPS are often used to speed up the procurement processes. Common types; 1. Management Contracting 2. Construction Management *** WPC – WORKS PACKAGES CONTRACTORS 16  MANAGEMENT CONTRACTING  As an alternative to the traditional approach, the client may decide to appoint a management contractor to engage and manage a number of work package subcontractors.  Management contracting enables the client to create a competitive situation between management contractors at the appointment stage of the project.  Management Contracting differs from other traditional procurement methods which the management contractor is appointed to manage the construction of the project rather than simply build it.  The Contractor is usually selected in bidding process. As well as the price, the experience and past performance of the management contractor is a major factor in the selection process.  Management Contracting is appropriate for large, complex projects where an early start is required. This is achieved by overlapping design, preparation of tender documents and construction.  In this situation the construction management consultant or construction manager joins the design team early in the project.  The construction manager’s services are based on a negotiated fee with the client simply to supervise and plan the work to be undertaken by the work package contractors. 17  MANAGEMENT CONTRACTING Management Contracting has the following advantages: 1. It lends itself well to complex construction projects as construction can start before design work is completed. 2. It allows flexibility for change as the works are tendered progressively. 3. It importantly allows an early start to be made on site before design is well advanced. 4. It creates a less involving relationship between Management Contractor and Employer. Management Contracting has the following disadvantages: 1. There is no contract sum is established at commencement of the works, the Employer relies upon the Quantity 2. Surveyor’s estimate. This is, however, endorsed by the Management Contractor initially and subsequently firm costs are established progressively during the course of the works. 3. It can lead to duplication of resources between trade-contractors and the Management Contractor and therefore higher tenders than would be the case under a more traditional procurement route. 4. The Employer has to accept a greater degree of risk because he has financial responsibility for the default of sub-contractors. 18  CONSTRUCTION MANAGEMENT Example on common Organization Structure of Construction Management 19  CONSTRUCTION MANAGEMENT The contraction management procurement is suitable for; Fast track projects Complex buildings A developing brief Disadvantages: Total cost of the project is not usually known until the project Damages for delay are difficult to pin on one subcontractor The client takes all the risk, particularly in the construction management 20  PUBLIC PRIVATE PARTNERSHIP Background  In line with the Government's new approach based on the new economic model in the 10th Malaysia Plan, the Government intends to stimulate its effort in encouraging the private sector to invest in development projects.  As such, the Government's allocation for development projects will be reduced and it can then shift its attention to projects that will be implemented and funded by the private sector whether through Privatisation and Public Private Partnerships (PPP), or through direct investment of the private sector in country's development programme. 21  PUBLIC PRIVATE PARTNERSHIP Background  The Privatisation Policy was launched in 1983 to support the Malaysia Incorporated Policy towards increasing the private sector's role in the country's economic development.  The main objective of this policy is to lessen the financial and administrative burden of the Government, improve skills and production, accelerate economic growth, reduce the size  and involvement of the public sector in the economy, and to assist in reaching the country's economic policy's  Private Finance Initiative Unit - PFI (currently known as Public Private Partnership) in line with the economic transformation effort towards being more competitive. 22  PUBLIC PRIVATE PARTNERSHIP Background Amongst the achievements in the implementation of the national privatization policy are:  Provided infrastructure facilities of world class stature such as the North - South Highway, the development of the Light Rail Transit (LRT), the Tanjung Pelepas Port and the development of the Kuala Lumpur International Airport (KLIA) projects;  Created local conglomerate companies which are successful and competitive such as the Tenaga Nasional Berhad (National Electricity Board) and Telekom Malaysia Berhad;  Provided employment opportunities in the private sector apart from producing a professional work force, especially amongst the Bumiputra; and  Energised the country's capital market through capital investments of the private sector in privatised Government projects. 23  PUBLIC PRIVATE PARTNERSHIP Is the basis of risk sharing relationship between public and private sectors that, in combination of each others, to initiate the project and create an end product that also desirable public policy outcome. To initiate, design, construct until completion public Public demand private 24  PUBLIC PRIVATE PARTNERSHIP A consortium is an association of two or more individuals,  This procurement is based on win-win situation. companies, organizations or governments with the objective of participating in a common activity or pooling their resources for  This scheme is a solution for the public where there is no/little cost achieving a common goal. to the government and includes infrastructure and public building work.  Upon the completion of work, both sectors could reap the benefits Public client with long-term strategies for employment  and the running of a completed scheme which is borne by the Advisor investor and not the tax payers. Equity Equity Provider of a Respondent consortium providers means an individual, corporation, joint venture, partnership or other legal entity who will have an ownership or equity interest in the Project, Main contractor Facilities manager Collaborative link 25 Contract link  PLANNING EXECUTION OPERATION Concept Set up client organisation for briefing. Consider requirements, appoints the consultant. Prepare general outline of requirements and plan future action. Project Control Turn over Feasibility study In order to achieve the Certificate of Completion Carry out studies of user requirements, site conditions, planning, design, cost, etc as necessary to best overall long term and Compliance (CCC) reach decisions. economics savings, it Start generate income To provide the client with an appraisal and recommendation in order that he may determine the should concern the Important part to playing form in which the project is to proceed, ensuring that it is feasible, functionally, technically and contractor’s method of physical asset financially. construction that comply maintenance management with the specification but The maintenance do not Definition have an impact on the life remain uniform or static Develop the brief further. Carry out studies on user requirements, technical problems, planning, cycle plan of the project throughout a project’s life design and costs as necessary to reach decisions. The method of and therefore need to be To determine general approach to layout, design and construction in order to obtain construction gives major reviewed at frequent authoritative approval of the client in the outline proposals and accompanying report. influence on the related intervals to assess their Schematic Design (SD) cost-in-use. implications within the Final development of the brief, full design of the projects by architect, preliminary design by For Project Control, the management of cost-in- engineers, preparation of cost plan and full explanatory report and submission of proposals for 5M: Materials, use. all approvals. Machineries, Manpower, Renovation/ upgrading/ To complete the brief and decide on particular proposals, include loaning arrangement Methodology, Money. refurbishment. appearance, constructional method. Outline specification and cost to obtain all approvals Tools for monitoring Demolition/ rebuilding/ Detailed Design (DD) (CPM, S-Curve, Cost reconstruction/ Full design of every part and component of the building by collaborating of all concerned, to Control...) redevelopment. complete cost checking designs To obtain final decision on every matter related to design, specification, construction and cost Procurement Procurement method is selected 26 Tendering the project will referring to Standard Form of Contract in implementing the project  FEASIBILITY STUDIES  A study on the current and expected availability of human, physical and financial resources  so as to ensure their optimum deployment, that can be measured according to specified criteria  The objectives of feasibility studies  in the context of prevailing and predicted commercial and socio-economic requirements.” not only to maximize profit,  but it is rather the economic study which provide information needed Involve large amount of related investment  due to the consequence of the Feasibility Quantitative For making project development. studies basis decision Or requires huge capital to be invest on projects 27  FEASIBILITY PROCESS Step 1 Step 2 Step 3 Step 6 Step 5 Step 4 28  FEASIBILITY STUDIES Step 1 Definition of a problem client Need to have an agreement on the define problem/studies with the solution to overcome it. consultant This need to be done at early phase or study as any changes to the definition of problem could cause changes and wastage of work will occur. 29  FEASIBILITY STUDIES Step 2  It is an activity to gather information on the resources that needed for the Data collection development.  Activities for data collection includes:  Choice of relevant alternatives and technology  Location  Infrastructure requirements of alternatives  Clients’ human and physical resources and availability of raw materials  A list of qualified and capable contractors with their skills and technology.  The market need to be investigated in order to determine the predicted price and sale ability of the product.  It is a basic requirement of feasibility study to be equipped with sufficient technical data to ensure the accurate calculation. 30  FEASIBILITY STUDIES Upon the selection of suitable alternatives (Step 2), the input need to be analyzed for making a prediction for the following: Step 3 Analysis Capital cost Programme Working capital and operational costs Indicate the duration Important as it of project determine the WC: can be calculated directly as percentage implementation and to the capital cost. The actual % depends on financial its subsequent the company's’ standard and procedure. requirement for a operation (Time and project. OC: can be calculated using the information activities) and records of other similar projects, usually a small % is allocated this cost. 31  FEASIBILITY STUDIES Step 3 Management cost Assessment on financial Market condition resources, their Analysis acquisition and cost Covers general management Normally, client would use his The product cost including client’s own money or to take a loan competitiveness with management expenditures with (i) for financing their its selling price need and supervisions of projects project. Hence, the duration of to be considered. (1-2% form total cost of the (i) that will be charged project) during the project commences until its completed need to be considered. 32  FEASIBILITY STUDIES Step 4  At this process, all the information gathered will be used for synthesized a project model.  The model might be produced in variety forms: commonly being used is Synthesis ‘cashflow’ model. 33  FEASIBILITY STUDIES Step 5 Several method for evaluation (investment techniques): Evaluation Net Present Value (NPV) Accounting rate of return (ARR) Payback method (PB) 34  C APITAL INVESTMENT APPRAISAL Firms have been found to use different methods when evaluating their capital investments, and may also be using multiple appraisal methods (APPRAISAL TECHNIQUES USED IN EVALUATING CAPITAL INVESTMENTS: CONVENTIONAL CAPITAL BUDGETING AND THE REAL OPTIONS APPROACH, 2005) 35  TIME VALUE OF MONEY The time value of money concept plays an important role in appraising capital projects because the time lag between the initial investment and payback can be quite long. RM1 earned or spent sooner, is worth more than RM1 earned or spent later. To evaluate any project taking into account the time value of money, the cash flows received in the future must be reduced or discounted to a present value, so that all relevant cash flows are denominated in todays value (present value). Example: 1, A person deposited RM1,00,000 in a bank for one year and got RM1,10,000 at the end of one year. Find out the total amount of interest and the rate of interest per year on the deposited money. Solution: The total amount of interest gained over one year = RM1,10,000 – RM1,00,000 = RM10,000 The rate of interest ‘i’ per year is given by; i% = RM10,000 x 100 = 10% RM1,00,000 36  INVESTMENT APPRAISAL A means of assessing whether an investment project is worthwhile or not Investment project could be the purchase of a new PC for a small firm, a new piece of equipment in a manufacturing plant, a whole new factory, etc. Used in both public and private sector Why do companies invest? Importance of remembering investment as the purchase of productive capacity NOT buying stocks and shares or investing in a bank! Buy equipment/machinery or build new plant to: Increase capacity (amount that can be produced) which means: Demand can be met and this generates sales revenue Increased efficiency and productivity 37  INVESTMENT APPRAISAL A fork lift may be an important item but what does it contribute to overall sales? How long and how much work would it have to do to repay its initial cost? 38  METHOD 1 - NET PRESENT VALUE (NPV) If we invest RM 100 at 20% interest, after one year it will be worth RM 120 and after 2 years it will be worth RM 144. NPV is the reverse of compound interest i.e if we were offered RM 120 one year from now and the inflation and interest rate was 20%, working backwards its value in today’s term would be RM 100. This called the present value, and when the cash flow over a number of years is combined in this manner the total figure is called NPV 39  NET C ASH FLOW Cash inflows: Receipts from sale of goods and services. Receipts from sale of physical assets. Cash outflows: Expenditure on materials, labour and indirect expenses for manufacturing. Selling and administrative. Inventory and taxes. 40  NET C ASH FLOW Cash-Flow Method  This model presents a more realistic and accurate assessment of development costs and income against the variable of time.  It is the nature of property development that the timing of cash-flows is irregular and uneven.  Some offices in high-rise buildings can be let or even sold off and allow the new owners to occupy the lower floors, even though the upper floors or other sections of the building are still under construction.  The model enables the developer to adjust for changes in interest rates easily over the development period or for different sources of finance. CIVE4406 CPM HaslinaMohamed 4 1  NET C ASH FLOW Discounted Cash-Flow Method  A discounted cash-flow (DCF) can examine different cash-flow models; they are all discounted back (i.e. using a present value formula) to a common point in time to facilitate an even comparison or analysis.  The time periods can be modified to any time period, such as days or years depending on the intended complexity of the DCF.  The main advantage of this approach to the developer is that it allows a subsequent calculation of the ‘internal rate of return’ (IRR), which is the measure used by some developers to assess the profitability of a scheme since IRR considers both the timing of the cash-flows and the magnitude of each cash-flow.  IRR is also ideal for comparing different potential property developments with their own variations in the timing and size of the cash-flows. CIVE4406 CPM HaslinaMohamed 4 2  EXAMPLE 1: NET PRESENT VALUE Discount factor = 12% 43  EXAMPLE 1: NET PRESENT VALUE (135,000)x 1.0 = (135,000) D0 = 1/ (1+12%)0 = 1.0 Present value interest factor (PVIF) Total 44  NET PRESENT VALUE (NPV) If the NPV is positive, it means that the cash inflows from the investment will yield a return in excess of the cost of capital and thus the project should be undertaken, as long as there are no other projects offering a higher NPV. If the NPV is negative, it means that the cash inflows from the investment yield a return below the cost of capital and so the project should not be undertaken. If the NPV is exactly zero, the cash inflows from the investment will yield a return which is exactly the same as the cost of capital and thus the project may or may not be worth undertaking depending on other investment opportunities available. CIVE4406 CPM HaslinaMohamed 45  ACCEPT OR REJECT CRITERIA FOR NPV METHOD Accept the project Reject the project NPV is positive. NPV is negative. In choosing between mutually exclusive projects, accept the project with the highest NPV. 46  METHOD 2- ACCOUNTING RATE OF RETURN (ARR) o The accounting rate of return method calculates the estimated overall profit or loss on an investment project and relates that profit to the amount of capital invested and to the period for which it is required. o A business will have a required minimum rate of return for any investment. This is related to the cost of capital of the business. o If an investment yields a return greater than the cost of capital, then the investment would be considered suitable and profitable. o The accounting rate of return is an average rate of return calculated by expressing average annual profit as a percentage of the average value of the investment. o Choose higher ARR (%) 47 (135,000)/6 EXAMPLE 2: ACCOUNTING RATE OF RETURN = (22,500) 6,666.7/(13 5,000) = 0.049 Average ARR Year 1 2 3 4 5 6 Net operating cash flow 14,000 25,000 35,000 36,000 30,000 35,000 Depreciation (22,500) (22,500) (22,500) (22,500) (22,500) (22,500) Operating profit (8,500) 2500 12,500 13,500 7,500 12,500 6,666.7 4.94% *Accounting Profit  14,000  22,500  (8,500) 48  ACCEPT OR REJECT CRITERIA FOR ARR METHOD Accept the project Reject the project Project ARR greater than the Project ARR less than the minimum required return. minimum required return. 49  METHOD 3 - THE PAYBACK METHOD It is a simple method, widely used in industry and is based on management’s concern to be reimbursed on the initial outlay as soon as possible. “how long before I get my money back?” The payback period (PB) is the period of time taken for the future net cash inflows to match the initial cash outlay. Many companies set payback requirement for capital projects. Definition - The length of time taken to repay the initial capital cost 50 EXAMPLE 3: PAYB ACK 51  EXAMPLE 3: PAYB ACK Cumulative calculation Year 1 =(135,000)+14,000 = (121,000) CIVE4406 CPM HaslinaMohamed 52  ACCEPT OR REJECT CRITERIA FOR PB METHOD Accept the project Reject the project Accept the project only if its payback Longer payback period period is shortest Payback period is greater than Payback period is less than that that required by owner. required by owner. 53  APPRAISAL METHODS Newport Leisure Park Ltd investment appraisal summary 54  FEASIBILITY STUDIES  After the process of data analysis and evaluation has been made, it is important for Step 6 the client  and consultant to agree on the appropriate schedules in the report as the objective Report and of this study is to find the best possible alternatives for a project. decision  A project is deemed more attractive when it could be implemented at a low risk with a reasonable price. 55  EXERCISE FOR TODAY : PAYBACK PERIOD Green Limited is planning to undertake another project requiring initial investment of RM50 million. The investment is expected to generate RM10 million in Year 1, RM13 million in Year 2, RM16 million in year 3, RM19 million in Year 4 and RM22 million in Year 5. Calculate the payback value of the project. +RM10M +RM16M +RM19M +RM22M +RM13M 1 2 3 4 5 -RM50M 56 57