Dharan Roads

In the middle of 1998, Mr. Malik, the financial manager of SADE, a Bahraini civil engineering company, was reviewing the contract it had just been awarded by the municipality of Dhahran in Saudi Arabia for the construction of a new road network linking the airport complex and the city. The life of the contract would be the remaining 6 months of 1998 and four full years over the period 1999 to 2003. The details of the five year contract awarded to SADE are described in Figure 1. Equipment would need to be purchased more or less immediately but the main costs and revenues would occur in the period 1999 to 2003. Given the initial advance, cash inflows and outflows in 1998 would be timed so that the maximum cash deficit of the contract at any time would be 11m SR. The construction work would continue until the end of 2002. The invoices (or “billings”) shown in Figure 1 could be treated as sales.

First of all, Mr. Malik planned to review his evaluation of the profitability of the contract and to check that it yielded more than the 15% return requested by SADE on projects in Saudi Arabia. (15% percent was also equal to the cost of financing for SADE for construction projects in Saudi Arabia).

Mr. Malik recognized that favourable results on a contract such as this depended on everything proceeding smoothly. Unfortunately, it seemed to him that it would be pure luck if the necessary combination of events were all to occur in his favour. Even though it was unpleasant, his thoughts began to turn to those aspects of the project that could go wrong.

He first wondered which of the various assumptions in his contract evaluation were particularly critical. He decided to make changes to one assumption at a time so that he could see which one had the largest impact on the value of the Dhahran Roads contract.

He felt more or less certain that the key factors that could jeopardize profitability would be cost overruns (such as higher equipment costs or increased...