Discussion. Evaluation of Bids for Construction Contracts Using Discounted Cash Flow Techniques.

Abstract

The concept of discounted cash flow has arrived on the business scene comparatively recently. It has attracted considerable support because, on the basis of some elegant arithmetic, it has provided a common language with which accountants and engineers (members of two normally incompatible professions) can converse. From the macro-economic point of view, it has the effect of diverting capital investment into projects for which the benefit is seen to lie in the near future, and away from projects for which the benefit lies, at least in part, in the far future. The higher the discount rate used, the less are we prepared to attribute a net present value to a benefit which lies some years ahead. The higher the discount rate, the more likely we are to build only for this generation rather than for posterity as a whole. Thank goodness our forefathers had not invented discounted cash flow when during the last century they built our railways, water, sewerage and harbour schemes! 100. My concern lies primarily in the fact that we use high discount rates. They are rarely in single figures, and frequently at around 20%. I believe that when government clients are using discount rate in a concept of unchanging money values, they use a figure of around 8%. If one discounts at 8% for 20 years, one gets as near zero as any estimator could arrive at.I believe this rate to be high, and that we should use a figure of about 29%. In choosing this value, I am attempting to quantify the reduction in the requirement for resources which will result from delaying the construction of the project, that reduction deriving from advancing technology. If we delay a project for a year, then something will improve, and we shall build it with less manpower, less machinery and less materials. The 2+%0 is just an order of magnitude ofgeneral growth available to a technological society. 101. In estimating for a project, the competing estimators have to make a large number of judgements concerning a barely conceived external environment in which the contractor will have to work. These judgements can.be expected to be distributed around the correct answer, and if they are capable of being plotted for purposes of comparison, will produce a Gaussian or skew curve. Some work has been done in bidding theory to illustrate the point. 16 The distribution results from the difficulty of making judgements over a large number of situations. The Paper is