Compute the experience curve, Business Economics

Compute the experience curve:

Chuck Raverty, General Manager of Carey Builders, a Baltimoreconstruction company is considering bidding for a construction contract on the new Corey Business School (CBS) building at Hopekeen State University.  Construction is scheduled to start in late summer 2013.  Chuck expects to compete for this contract with Wharton Construction, an out-of-state rival.  There is also a chance that the Smith Corporation, a construction company based in Silver Springs, MD will bid on the contract.

Carey has completed four such university building projects so far and is working currently on a similar project that will be completed before the CBS project starts in 2013.  Thus, Carey will have the experience of having completed five projects when it starts the CBS project, if it wins the contract. The latest completed project (i.e., their fourth) cost Carey a total of $34.3 million, of which $25.8 million was raw material cost.  Also, an internal cost analysis has shown that Carey's second project (completed in 2002) cost a total of $30.0 million, of which the raw material cost was $20.0 million.  Since all the projects that Carey has worked on are structurally similar, Chuck expects this cost dynamic to hold for his future value-added costs and believes that this past cost information may be useful for forecasting purposes.

Hutt and Speh (HS) Corporation, a leading building supplies company has informally agreed to supply all the raw material for the CBS project for $43.9 million. Chuck knows that the costs of gearing up to submit a bid on the CU project would involve incrementalfixed costs of $75,000, nonrefundable contract guarantee fees to HS Corporation amounting to 1% of the contracted raw material cost, and setup costs equal to 2% of the project's value-added costs. Thsee "bid development costs" are not recoverable (and must be written off) if Chuck fails to win the bid.  Hence, Chuck wants to include these costs in figuring his bid.

Phil Ferrari, Chuck's former graduate school buddy is the Senior Contract Manager for Hopekeen University and reminded Chuck that because of priorities favoring in-state awards, Carey has an advantage if it bids on the CBS building. Chuck thought this was encouraging.  He assesses that if bidding only against Wharton, Carey's probabilities of winning the contract at bid prices involving specific markup levels on forecasted total costs are (no intermediate markups, e.g., 7% or 18%, are allowed):

            Markup:                                                            0%       5%       10%      15%      20%      25%

            Probability of contract award to Carey                  1.0        0.8        0.7        0.4        0.3        0.0

A.  Compute the experience curve implied in Carey's past project costs.

B.  Compute what Carey should forecast for value-added costs for the CBS project.

C.Compute Carey' total ($) cost for the CBS project and (for each bid markup level) the associated gross ($) profit margin if it wins the CBS contract.  (Assume that HS Corporation will meet its raw material price commitment)

D. What $ amount should Carey bid for the project (assume Chuckmaximizes expected profit)?

E. Chuck now learns that Smith Builders is also certain to bid on the LSB project.  Carey will then lose the in-state advantage and Chuck's revised estimates of the probability that Carey will win theCBS contract are:


            Markup:                                                            0%       5%       10%      15%      20%

            Probability of contract award to Carey                  1.0        0.7        0.4        0.3        0.0

What should Carey bid for the CBS project given this information (recall that Chuck maximizes expected profit)?

F.  How will your answer change if Chuck felt that there was only a 50% probability that South State would bid on the project?  Show your computations and briefly explain your answer.

G.  Chuck wonders if maximizing expected profits is a good approach to making these decisions and seeks your advice on whether to bid higher or lower than the expected profit maximizing bid.  What advice would you give him?

H.  Chucklearns that Hopekeen Statepalns on building an executive education facility in 2015 and that the CBS contract winner will have an inside track in the bidding.  Should this information affect his bid on the CBS project?  Why or why not?

Posted Date: 2/12/2013 2:59:11 AM | Location : United States

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