Learning_from_Past_Mistakes_Telecommunication_Contractor

Dania Construction Services Sdn. Bhd. Synopsis Dania Construction Services Sdn. Bhd. (DCSSB) is a PKK class ‘A’ contractor registered to provide trades and services in civil, electrical and telecommunication construction. Their main client is the national telecommunication service provider, Telekom Malaysia Berhad. The company has been through a lot of financial problems in the early stage of its establishment and has survived many ups and downs throughout managing its growth. In June 2012, it faces another challenge in managing the sustainability of its growth. A new big project has been secured by DCSSB which is to start in July 2012 and another project seems also to be coming their way. The company has a few decisions to make by the Management, with regards to their capital budgeting to ensure the sustainability of their business for the coming years. Introduction DCSSB was built by 3 friends who went to the same local university back in the 1990’s. All of them spent few years as engineer and accountant to gain some experience in the working environment before they decide to quit their job and form DCSSB. This is something that they had planned since they were still university students. Their main reason to set up their own company is to take advantage of the growing economies of the region and considering only limited number of ‘bumiputeras’ venturing into these business in the country. These 3 friends have always been sharpening their entrepreneurial skills since their university days by joining many extra-curricular activities which involve dealing with business set-up. They seems be well prepared for the challenges they will face ahead without any support or guidance from any organisation. Ir. Azmi b. Baharuddin graduated as a Civil Engineer and employed in a huge construction company and has working skill for 5 years before quitting and formed DCSSB. Ir. Badrul Hisham b. Ahmad graduated in Electrical and Telecommunication Engineering and served at the biggest local telecommunication company after graduation. Mr. Chamil b. Adnan worked as an accountant in a large construction company for prior to forming DCSSB. These Trios have a very outstanding job track record during their tenure in various companies. Even though their last drawn salaries are up to five figures but they dare to take the challenges in the business that gave no promises. Although they were physically and mentally prepared for the entrepreneurship, no prior working experience could have prepared them for the challenges that they had to face in the first few years of the company setup. Of course they face the hardships at initial stage but later they manage to stable down after securing some decent projects. Just after 3 years of operational, the world was hit by economic downturn thus followed by the region and the country was also not exceptional. At that point of time, DCSSB was gearing itself up in accordance to their business plan. They have just completed their biggest project at that time, worth RM 5 million and were in the midst of preparing the company for the next big project. The project required them to invest in new equipment and to recruit more skilled-workers. Unexpectedly, the project had to be deferred by the telecommunication company due to the worsening economic situation. The decision to defer the project was made in the eleventh hour by the Client as they have to reorganise the projects that has been awarded earlier. Prior to this, DCSSB has already taken the proactive steps in procuring equipment and machineries to cater for the expected project in the previous year. In order to make the purchase, DCSSB has taken a loan facility with Bank Bumiputra worth RM 4 million, to be paid in the next 5 years. They have even invested in a 5 acres land to build a factory at Batu Gajah, Perak which manufacture concrete manholes. They made this investment in order to minimise their material cost and control their own supply chain. However the factory only managed to operate for quite some time and only produced quite a number of concrete manholes. Due to the deferment of the project, they were stranded with unutilised equipment, machinery and excess supply of materials at the factory. The deferment of the project has caused DCSSB to be burdened with a long term debt, loss of income and therefore inability to repay the debt due to deferment of the project. With the increasing unpayable debts from month to month, they had no choice but to turn to Pengurusan Nasional Danaharta Berhad (Danaharta) to assist them with the loan repayment. However later Danaharta couldn’t manage to assist them because there is no fixed income for the company and no new projects coming in. To worsen the situation, their assets including the factory were seized by Danaharta and will only be returned after the loan repayment of their debts. At this juncture Danaharta is not supporting them because even though at present the value of the confiscated assets is more than their debt amount but Danaharta refused to sell them. They just want the loan amount be settled and they will return the assets. This has soar them further because besides paying their debts, they also have to face the increasing amount of debt interest and fees to be paid to Danaharta. However Danaharta has allowed them to manage their bank account freely but have to complete their payments at a certain period of time. These obstacles and restrictions has not demoralised them even though they are aware that they will be facing the hard times ahead. By ignoring those hardships, on moving forward DCSSB has taken an early step by managing their cash flow in a very strict manner. By doing this they would to be able to run their business efficiently and at the same time able to pay their outstanding debt at a negotiated amount. At this stage, DCSSB is now are more careful in making huge investments such as building a new factory, acquiring new assets and at the same time reducing unfavourable expenditures as not to repeat their previous mistakes. Even their wages are cut down to half. All Investment decisions are now made with careful consideration and deliberation among the management team, based on the affordability and the cappability of the company. Company Background DCSSB was incorporated in 1995 at Ipoh, Perak. During the initial stage, they started the venture as an electrical, telecommunication and civil contractor. However, most of the projects that they manage to obtain were civil works. Just after just 2 years on starting the business, they managed to obtain the ‘Jadual Kadar Harga’ (JKH) license from the national telecommunication provider, Telekom Malaysia Berhad (Telekom). From then on, they focused their business as a JKH Contractor for Telekom projects. The main scope of their projects are supplying and erecting manholes for Telekom throughout the country. Besides, they are also managing telecommunication lines and as well doing the piping work for the Telekom. Through hard work and their dedication to the job, they managed to increase their paid-up capital amounted to RM 1,000,005.00 at the short period of time. Later in 1998, they managed to secure a RM 10 million contract with Telekom after completing a contract worth RM 5 million. According to the plan they could fetch up to 45% profit from the awarded project. That contract requires DCSSB to supply concrete manhole for Telekom for the entire Peninsular Malaysia for the next 5 years. Since this contract is a long term contract, DCSSB decided to invest in having its own factory at Batu Gajah Industrial Estate, Perak. However, in 1998, the nation was badly hit by recession following the world economic downturn and that affects Telekom as well. Following that, Telekom decided to scale down their number of projects in order to reduce its expenditure, and withdraw some of the projects that have been granted earlier. This decision has badly affected DCSSB as they have just made a huge investment on debt based on the long term projections. They have no choice but to force to switch to Danaharta for assistance in handling their debts. For the immediate survival they had to downsize their resources in order for the company to move forward even at a very slow rate. At meantime they cannot solely depends on Telekom as they have to pay their debts promptly. They have to look for projects other than Telekom. With the good relations and links towards other telecommunication companies, they were able to secure some small contracts with Celcom and Time Dot Com based on their experience and good track record with Telekom. Later in within the 5 years’ time, they managed to survive in the difficult period and get back to growing its’ business. This time they are more careful in managing the funds and accounts as they have learned through their past mistakes. The management team of DCSSB is led by the Managing Director (MD), Ir. Azmi b. Baharuddin who is also the co-founder of the company. The other 2 co-founders, are Ir. Badrul Hisham b. Ahmad and En Chamil b. Adnan also hold a management position as the Chief Operating Officer (COO) and the Chief Financial Officer (CFO), respectively. Over the years, they have built a strong foundation of successors in terms of technical capability as well as business managers. They have also teamed up with other ‘Bumiputera’ contractors in order to be able to scale up their resources when required, without unnecessary burdening their financial situation. DCSSB has been recognised by their clients in terms of their quality of work and services as well as the professionalism of its management and the technical team. They are ISO certified and implement Just-In-Time procurement strategy and well as practise lean management in their day to day activities. Their projects were always completed ahead of schedule with superior quality. The management of DCSSB has decided to move from Ipoh, Perak in 2006 to Kuala Lumpur and their office is currently based at Cyberjaya, Kuala Lumpur.   Figure 1: DCSSB’s Organisation Chart Source: Company’s Profile   Issues DCSSB is currently considering a purchase of one set of Optic Cable Splicing Machine to enable them to undertake the works for the new project efficiently. They have just secured a contract worth RM 10 million for 3 years duration. The scope of works is to install Copper and Fibre Optic Cables for Telekom. Their scope is to provide the man power, machinery and equipment as well as the technical services. Material for installation will be provided by the Client. DCSSB requires this new machine by July 2012, approximately a month from now. The machine, if properly operated and maintained, could be used for up to 5 years. The manufacturer of the machine has agreed to provide an instalment facility to DCSSB at an interest rate of 9% annually. Based on the CFO’s calculation, DCSSB can only afford to pay at most, RM 20,000 per month for the instalment, for the next 48 months. There are 3 models of machine available by the manufacturer with cost ranging from RM 500,000.00 to RM 1,000,000.00. The most expensive machine would provide the highest efficiency. Their options are as per the table below. Model No Price (RM) Efficiency ABC 3001 1,000,000.00 Best ABC 2001 800,000.00 Moderate ABC 1001 500,000.00 Basic Recently, the MD of DCSSB was also approached by a novice private communication service provider for a potential project to install Fibre Optic cables at a large new development area. The total cost of this project is RM14 million. The payment for this project will be made according to the physical progress of the project. The project is also expected to be completed in three years and to start in July 2012. When the MD discussed this potential project with his management team, they were all excited with the prospect of the project as they have never been approached by a private communication service provider before and this opportunity means a new network of clients, not to mention the higher expected income. However, the payment will only be made according to the physical progress and based on the COO’s estimation the progress of the project will be as follows: Year Progress Year 1 30% Year 2 30% Year 3 40% Their current secured project, although it value is less than RM 14 million, includes an advanced payment of RM 1 million and a bi-annually payment of RM 1.5 million throughout the project duration. Conclusion The MD of DCSSB has a few important decisions to be made immediately. He needs to decide which machine they should procure based on their affordability. He also has to evaluate the viability of 2 projects; 1 has already been secured while another is still at the proposal stage. If he decides to take both projects, DCSSB needs to grow its’ resources and this will require them to take up a bank loan, which is not his preference at the moment. At this juncture, DCSSB does not have enough information on the detail cost plan of the project. They only have the expected payment schedule for each project. The CFO suggested a simple valuation analysis using time value of money to compare the viability of both projects. The MD wasn’t convinced that this simple analysis is sufficient but he asked the CFO to conduct the analysis anyway for their next management meeting. Questions 1. Identify the Cash Flow involves in this case. 2. Based on their affordability, which model of the machine should they purchase' 3. Assuming DCSSB has the capability for only ONE project within this 3 years period, which project would be more lucrative' Why' (Assume the annual interest rate as 9%) Answers 1. There are 2 types of Cash Flows involved in this case which are: • Annuity: Annuity is a level stream of regular payments that lasts for a fixed number of periods. Annuities are the most common kinds of financial instruments. In this case, the annuity cash flow is represented by a monthly instalment of RM 20,000.00 for a 48 months period. • Series of Cash Flow, multi-period: Series of Cash Flow, of different amount which was presented in terms of expected milestone payments to DCSSB throughout the duration of the projects. - Series of Cash Flow for Project 1: An advanced payment of RM 1million made on Timeline 0 and annuity cash flow of RM 1.5 million for the next 6 months (3 years) period. - Series of Cash Flow for Project 2: Payments of RM 4.2 million to be made in Year 1 and 2 and a payment of RM 5.6 million in Year 3. 2. Base on affordability, DCSSB can only afford to pay at most, RM 20,000 per month for the instalment, for the next 48 months. There are 3 models of machine available by the manufacturer with cost ranging from RM 500,000.00 to RM 1,000,000.00. The most expensive machine would provide the highest efficiency. Their options are as per the table below. Model No Price (RM) Efficiency ABC 3001 1,000,000.00 Best ABC 2001 800,000.00 Moderate ABC 1001 500,000.00 Basic Solution: Calculate the Present Value of the annuity payment of RM 20,000.00 for 48 months in order to estimate the affordable price. Interest rate has been given as 9% annually. However, do take note that the payments are made monthly. Therefore adjustment for the compounding period has to be made accordingly. Formula for Calculating Present Value of Annuity: Where C=RM 20,000, r = 0.09/12 , t = 48 months Therefore, DCSSB should purchase Model ABC 2001 based on their affordability.   3. In order to conduct a simple analysis as suggested by the CFO, we need to calculate the Present Value of payments for Project 1 and Project 2. 3.1 Project 1 offers an advanced payment of RM 1 million and a bi-annually payment of RM 1.5 million throughout the project duration making up a total payment of RM 10 million. Calculate the Present Value of semi-annually compounded payments of RM 1.5 million for the next 3 years – 6 annuity payments of RM 1.5 million. The Present Value of the advanced payment remains as RM 1 million as it happens on Timeline 0. Timeline of Cash Flows for Project 1: RM 1,000,000 + RM7,736,808.72 = RM8,736,808.72 Therefore, the Present Value for payments of Project 1 is RM 8,736,808.72.   3.2 The total payment for Project 2 RM14 million. The payment for this project will be made according to the physical progress of the project. The project is also expected to be completed in three years and to start in July 2012. The progress of the project will be 30% in Year 1 and Year 2, while for Year 3 with progress 40%. Calculate the Present Value of the Multiple Cash Flows. Timeline of Cash Flows for Project 2: PV1 = 4.2 million /(1.09) = 3.85 million PV2 = 4.2 million /(1.09)2 = 3.54 million PV3 = 5.6 million /(1.09)3 = 4.32 million Alternatively, PV1 & PV2 can be calculated as annuities. Therefore, total Present Value for payments of Project 2 is RM11.71 million.   3.3 The Present Value for total payment of Project 2 is higher than Project 1. This is not surprising as the total payment for Project 2 is RM 14 million compared to only RM 10 million for Project 1. However, this does not mean that Project 2 is more lucrative than Project 1. Valuation of projects is normally done using the Net Present Value method which considers the outflow of Cash Flows as well as the inflow of the Cash Flows. The investment of the machine at the early stage of the project is only one of the various outflows of the projects. The actual operating cost of the project throughout the 3 years project duration needs to be estimated in order to see which project will have the highest Net Present Value figure. NPV = PV - Cost