Financial Management of Projects and Contracts Lecture 1

Financial Management for
Projects and Companies

Training Course and Workshop
By
Fawzy Harraz
Cairo, October 2022
Financial
Financial Management
Management
for
for Projects
and Companies
Financial Management for

Cairo, October 2022 2 by : Fawzy Harraz

for Projects and Companies
Networking First;
Who are We?
Instructor
Fawzy Harraz
1) B.Sc. Marine Engineering and Naval Architecture
2) Chartered Engineer from UK Engineering Council.
3) Member of Institute Of Marine Engineering, Science and Technology
4) Member of the AACE
Forty years diversified experience in engineering, asset development, project
management, project controls (cost engineering, planning and scheduling,
risk management), value assurance and operations planning. Main business
areas include offshore/onshore upstream O&G facilities, midstream
Hydrocarbon Projects (Refineries, and NGL) and downstream petrochemical
plants, Power Plants and Infrastructures. Experience with both green field
and brown fields projects and plant TAR management.

Introduction
Administrative Processes
Safety/Escape Process
Getting known to each other
Use of the Manuals and handout notes.
Occasional challenges and Q&A’s
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byby: Fawzy Harraz
Cost Management Overview

Course Mission
1. Value driven !
2. Interactive dialogue
3. Flexible to Participant specific needs
4. Pragmatic (Modern trends addressed)
5. Industry driven.
6. Just a start !!!.
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October 2022 55 byby : Fawzy
: Fawzy Harraz
Harraz
The Mission; Why we are Here

Financial Management of Projects/Companies
Mission Statement
1. Understand basics of Economics (NPV, DCF, costs,
revenues and profits)
2. Applying these to investment proposals
3. Applying optimum pricing to ensure winning and
delivering profitable projects
4. Proper planning and cost estimation of Projects.
5. Validating the profitability of the proposed project.
6. Putting the right Contract terms and conditions for a
winning project/business.
7. Ensuring proper fair flow of cash into the Project
8. Continued close look and care to potential risks and
required mitigation methods.

Financial Management of Projects/Companies
Mission Statement ‘cont’
9. Continued performance monitoring of the project and
taking recovery actions as/when needed.
10. Documenting and sharing lessons at Project closeout.
11. Wrap up values of the Course and plan a way forward
and career path.

Next slides show how we get there;

the Course Content

Course Outline
Module 1 - Fundamentals of Finance
1. Time value of money
2. Discounted cash flows
3. Direct vs. indirect costs
4. Fixed, variable and semi-variable costs
5. Break-even analysis
Module 2 - Contract Profitability - Pricing

1. Pricing strategy and tactics
2. Profit planning
3. Cost estimating (under Module 5 Agenda)
4. Cost-based pricing
5. Market-based pricing
6. Value-based pricing
Course Outline
Module 3 - Asset Management
1. Cash
2. Timing of cash flows
3. Inventory
4. Equipment
5. Revenue recognition
6. Financing arrangement
Module 4 - Key Financial Management issues
1. Managing Risks
2. Scenario and Sensitivity Management
3. Earned Value Analysis (EVA)
4. Variance Analysis
5. Contract Terms and Conditions
6. INCOTERMS (INternational COmmercial TERMS)
Course Outline
Module 5 - Cost Estimating - What Works Best
1. Cost estimating
2. Planning and scheduling
3. Making sense of historical data
4. Experience curves
5. Relationship between cost estimating and pricing.
6. Using Excel® to analyses historical data

Break
Project Model
Throughout the Course we will be applying Financial Concepts
to a specific project Model. Two cases will be considered:
a) The Company is a Contractor.
The Project basic Data:
1. Project Sale price 500 MM $
2. Project Cost 400 MM $
3. Terms of Payment
• Advance payment 10% of the Lump sum
• Progress payment based on physical progress
(VoWD)
• Fixed costs paid on level of effort
• Payment 30 days from invoicing
• Variation settled and paid before start
4. Performance guarantee bond 10% to be released 1 year
from
Cairo, October 2022Provisional acceptance.
13 by : Fawzy Harraz
Project Model ‘cont’

b) The Company is an Owner.
In some topics, the case of Oil and Gas Operator in the
business of Methanol and downstream process will be
used in the discussions in Life Cycle Costing (LCC),
economics scenarios and sensitivities.

Time value of money

Time Sooner the Payment

The better the business

Time value of money

1. The time value of money (TVM) means that money
available at the present time is worth more than the
same sum in the future due to its potential earning
capacity, inflation..
2. This core principle of finance is that, provided money
can earn interest, any amount of money is worth more
the sooner it is received.
3. TVM is also referred to as present discounted value.
For example, money deposited into a savings

account earns a certain interest rate and is therefore said
to be growing or compounding in value.

Importance of Time value of money

1. Can save company from insolvency/bankruptcy Or
vice verse (cause Co. to go into insolvency)
2. Can improve annual profits Or vice verse (reduce)
3. Enable Company to catch business opportunities Or
vice verse (lose business opportunities).
4. Impact Company reputation positively or negatively.

Importance of Time value of money ‘cont’

Example:
If you have the option to choose between receiving
$10,000 now versus $10,000 in two years, you will
definitely go for the first option.
Despite the equal value, at time of payment, receiving the
$10,000 today has more value than receiving it in the
future due to the opportunity costs of waiting.
Such opportunity costs could include the potential gain
on interest if that money is received today and held in a
savings account for two years.

Time value of money

Basic TVM Formula
In general, the fundamental TVM formula is:
FV = PV x [ 1 + (i / n) ] (n x t)
Where:
FV = Future value of the “money of the day”
PV = Present value (money of the day)
i = interest rate
n = number of compounding periods per year
t = number of years

Time value of money TVM

Example on TVM
If $10,000 is invested for one year at 10% interest.
The future value of that money is:
FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000
The formula can also be rearranged to find the
value of the future sum in present day dollars. For
example, the value of $5,000 one year from today,
compounded at 7% interest, is:
PV = $5,000 / (1 + (7% / 1) ^ (1 x 1) = $4,673
This is the discounted current value for a future
amount. See the next Topic “Discounted Cashflow”

Time value of money

Effect of Compounding Periods on Future Value
The number of compounding periods effects TVM. For
$10,000 example above, if we compound quarterly,
monthly or daily, the future value calculations are:
Quarterly Compounding:
FV = $10,000 x (1 + (10% / 4) ^ (4 x 1) = $11,038
Monthly Compounding:
FV = $10,000 x (1 + (10% / 12) ^ (12 x 1) = $11,047
Daily Compounding:
FV = $10,000 x (1 + (10% / 365) ^ (365 x 1) = $11,052
TVM depends on interest rate, period and also on number
of compounding times each year.

Real Life Project Example (500 MM $ Project)

Contractor Cashflow curve (10% advance Payment)
120 60
50
Net Monthly cashflow, MM $

100
50
98
97
96
Monthly and Cumulative cashflow
Cumulative Cashflow, MM $
94
100
93
92
91
89
40
83
79
74
80
72
70
30
65
55
60 20
53
51
50
50
49
48
48
47
46
45
45
44
44
10
10
42
41
40
39
10
38
6
40
4
3
3
2
2
2
2
2
2
2
1
1
1
0
0
0
0
0
-1
-1
-2
20
-2
-5
-10
Net Monthly cashflow Net cum cashflow
-10
0 -20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34
Months from Project Start

Real Life Project Example

Contractor Cashflow curve (5% Advance Payment)
1. of the money (installments) along the curve
120 30
25
Net Monthly cashflow, MM $

100
97
97
96
Monthly and Cumulative cashflow
Cumulative Cashflow, MM $
100
93
92
91
20
89
86
80
75
11
80
11
69
66
10
63
7
6
6
57
5
60
4
4
4
3
3
3
3
3
2
2
1
1
45
0
0
0
42
38 0
35
0
-1
40
31
23 -2
22 -2
27
18 -4
25
25
24
24
23
22
22
22
19
-10
20
13
-10
Net Monthly cashflow Net cum cashflow

0 -20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34
Months from Project Start

Real Life Project Example

Cashflow curve
1. The numbers in the graph are ‘Money of the Day’
2. Although the end value is numerically 100 MM $, its
real value “today’ is less than 100 MM $. Time Value
impact gives different value less than 100 $.
3. The discount in the ‘Money of the Day’ when paid in
future depends on:
a. Interest rates
b. Compounding periods
c. The distribution of the money (installments) along
the curve

Discounted cash flow DCF


Discounted cash flow (DCF) analysis is a method of
valuing a project, company or asset using the concepts
of the time value of money.
DCF is used to estimate the value of an investment

based on its future cash flows,


DCF calculates present value of expected future cash
flows using a discount rate to decide on a potential
Project, Contract or investment.
If the value calculated through DCF is higher than the
current cost of the investment, the opportunity should
be considered. DCF is calculated as follows:
DCF= CF1/(1+r)+CF2/(1+r)2+CF3/(1+r)3…+CFn/(1+r)n
• CF = Cash Flow
• r = discount rate.
• The discount rate is normally taken as the WACC
(Weighted Average Cost of Capital); slides 34 ..36.
Example on DCF
DCF=CF1/(1+r)+CF2/(1+r)2+….
Discount rate 12.0%
Year Annual CF 1+r (1+r)n DCF
Year 1 15 112% 112% 13.4
Year 2 15 112% 125% 12.0
Year 3 15 112% 140% 10.7
Year 4 15 112% 157% 9.5
Total cash inflow 45.6
Salvage value 12.0
Total project value 57.6
Original investment 50.0
Investment return 7.6


How Discounted Cash Flow (DCF) Works
1. DCF uses the time value of money i. e. a dollar today
is worth more than a dollar tomorrow.
2. On a 5% annual interest, $1.00 in a savings account
will be worth $1.05 in a year. Similarly, if a $1 payment
is delayed for a year, its present value is $.95 because
it missed the benefit of the saving account.
3. DCF analysis is a tool to confirm the fair stock value
prices published by analysts.
4. It considers many factors that affect a company,
including future sales growth and profit margins.


How Discounted Cash Flow (DCF) Works ‘cont’
5. DCF can be very helpful for evaluating individual
investments or projects that we can control and
forecast with a reasonable amount of confidence.
6. DCF analysis also requires a discount rate that
accounts for the time value of money (risk-free rate)
Depending on the purpose of the investment, there
are different ways to find the correct discount rate.


Alternative Investments
1. An investor can set a discount rate equal to the
return he expects from an alternative investment of
similar amount with a similar risk.
2. You can invest $500,000 in a new home that you can
sell in 10 years for $750,000. Alternatively, you could
invest $500,000 in a real estate investment bond
that is expected to return 10% annual for the next 10
years.


Limitations of DCF Model:
1. When applied too broadly or with bad assumptions.
For example, the risk-free rate changes over time and
may change over the course of a project.
2. Changing cost of capital or expected salvage values
at the end of a project can also invalidate the analysis
once a project or investment has already started.
3. Applying DCF models to complicated projects, where
we cannot control, is also difficult or nearly
impossible.
Real life Example; Kashagan Project


Summary
1. In order to conduct a DCF analysis, an investor must make
estimates about future cash flows and the ending value
(salvage) of the investment, equipment, or other assets.
2. The investor must also determine an appropriate discount
rate for the DCF model, which will vary depending on the
project under consideration. If we cannot assess the
future cash flows, or the project is very complex, DCF will
not have much value and alternative models should be
employed, such as pay-back period, Internal Rate of
Return IRR or NPV (net present value).

Weighted Average Cost of Capital (WACC)

The WACC, is defined by the formula:
WACC = E/V * Re + D/V * Rd * (1 - Tc)
Re = Cost of equity
Rd = Cost of debt
E = Market value of the firm's equity
D = Market value of the firm's debt
V = E + D = Total market value of Company or
Project
E/V = Percentage of equity financing
D/V = Percentage of debt financing
Tc = Corporate tax rate


1. Example on WACC
Assume that:
Cost of equity Re 9% Rate for Stockholders
Cost of Debt Rd 14% Rate for Indebtors
Market value of Company equity E 950
Market value of Company debt D 1,500
Total market value of Comp. V= (E+D) 2,450
% of equity financing E/V 39%
% of debt financing D/V 61%
Corporate tax rate Tc 0.20
WACC = (E/V * Re) + (D/V * Rd * (1 - Tc)) 10%
The smaller the better !! And vice verse


1. When evaluating a project, we use (WACC) as a
discount rate. WACC is the average cost of capital.
2. If we can invest $50 Million in a project expected to
give $15 MM dollars a year for 4 years and a salvage
value of $12 MM. If the WACC is 12%, a DCF analysis
is shown next slide.
3. In this case, we should invest in the project because
the DCF analysis results $57.56 MM compared to
$50.0 MM initial investment.

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Financial Management for

Projects and Companies

Financial Management for

Cairo, October 2022 2 by : Fawzy Harraz

Cairo, October 2022 3 by : Fawzy Harraz

Cost Management Overview

The Mission; Why we are Here

The Mission; Why we are Here

Cairo, October 2022 7 by : Fawzy Harraz

The Mission; Why we are Here

Next slides show how we get there;

Cairo, October 2022 8 by : Fawzy Harraz

Module 2 - Contract Profitability - Pricing

Cairo, October 2022 11 by : Fawzy Harraz

Project Model ‘cont’

Cairo, October 2022 14 by : Fawzy Harraz

Time value of money

Cairo, October 2022 15 by : Fawzy Harraz

Time Sooner the Payment

Cairo, October 2022 16 by : Fawzy Harraz

Time value of money

For example, money deposited into a savings

Cairo, October 2022 17 by : Fawzy Harraz

Importance of Time value of money

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Importance of Time value of money ‘cont’

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Time value of money

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Time value of money TVM

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Time value of money

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Real Life Project Example (500 MM $ Project)

Net Monthly cashflow, MM $

Months from Project Start

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Real Life Project Example

Net Monthly cashflow, MM $

Net Monthly cashflow Net cum cashflow

Months from Project Start

Real Life Project Example

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Discounted cash flow DCF

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Discounted cash flow DCF

DCF is used to estimate the value of an investment

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Discounted cash flow DCF

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Discounted cash flow DCF

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Discounted cash flow DCF

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Discounted cash flow DCF

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Discounted cash flow DCF

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Discounted cash flow DCF