Choosing Between Two Berth Options and Dealing with an Unbalanced Tender
A port authority must provide one additional 350 m bulk berth under a 25-year concession. Option A is a new berth on reclaimed land: USD 180M at year 0, net operating cash flow of USD 22M/yr, and a residual value of USD 20M at year 25. Option B is an upgrade of an existing berth with capital dredging: USD 95M, net cash flow of USD 14M/yr, a mandatory USD 25M rehabilitation at year 12, and no residual value. The real discount rate is 8%. Traffic forecasts have been cut twice in five years; the current forecast is 3.2 Mt/yr with a standard deviation of 18%. Tenders for Option B have come in as follows. The engineer's estimate for the 800,000 m³ dredging item is USD 28/m³. Bidder 1 prices dredging at USD 41/m³, about 35% of his total bid, and prices the quay wall low; his total is USD 93.7M. Bidder 2's total is USD 97.4M, 4% higher, with balanced rates close to the estimate. The board wants a recommendation in three weeks, before the concession bid deadline.
1. Calculate the NPV of both options and the incremental return on the extra capital committed to Option A.
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Discount factors at 8% over 25 years.
- Annuity factor: (1 − 1.08⁻²⁵)/0.08 = (1 − 0.1460)/0.08 = 10.675.
- Present value factor, year 25: 0.1460.
- Present value factor, year 12: 1/1.08¹² = 0.3971.
Option A
- PV of net cash flow: 22 × 10.675 = 234.9
- PV of residual value: 20 × 0.1460 = 2.9
- Less capex: −180.0
- NPV = +USD 57.8M
Option B
- PV of net cash flow: 14 × 10.675 = 149.4
- Less capex: −95.0
- Less rehabilitation at year 12: 25 × 0.3971 = −9.9
- NPV = +USD 44.5M
Incremental analysis (A minus B)
- Δ cash flow: +8/yr × 10.675 = +85.4
- Δ residual: +2.9
- Δ capex: −85.0
- Δ rehabilitation avoided: +9.9
- Incremental NPV = +USD 13.2M
A annualised at the capital recovery factor of 0.0937, A is worth about USD 5.4M/yr equivalent and B about USD 4.2M/yr.
Interpretation. A wins, but the margin is thin relative to the capital employed: 85M of extra capital buys 13.2M of NPV, so the incremental IRR is only about 9.5% against an 8% hurdle. Both options clear the hurdle; the decision hinges on how much confidence the authority has in the extra 8M/yr of net cash flow that only A delivers.
2. Test the robustness of the ranking and recommend how the authority should structure the decision.
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Sensitivity 1 - throughput. The incremental NPV of 13.2M is delivered by 8M/yr of extra net cash flow, so A's advantage disappears if its net flow falls by 13.2/10.675 = USD 1.24M/yr, i.e. 5.6% of 22M. The forecast standard deviation is 18%. A one-sigma downside is roughly 4M/yr, which is three times the break-even. On the central case A wins; on a plausible downside B wins comfortably.
Sensitivity 2 - discount rate. The incremental IRR is about 9.5%, only 1.5 points above the hurdle. A small reassessment of the real discount rate, or adding a country or concession risk premium, flips the ranking. The decision is more sensitive to the discount rate than boards usually assume.
Sensitivity 3 - downtime and residual value. B's year-12 rehabilitation will close or restrict the berth; if it takes six months at 60% capacity, B loses a further ~4M of NPV and the gap widens. Conversely, A's 20M residual at year 25 is a soft number.
Sensitivity 4 - strategic fit. A gives deeper water and a larger vessel capability that B can never provide; B gives redundancy and lower capital at risk. NPV alone does not price the option to expand.
Recommended structuring.
- Do not commit to A on the central forecast alone. Select B, but design the upgrade so that the berth can later be extended to A's capacity - that preserves much of A's strategic upside at B's risk level.
- Alternatively, select A only if the concession includes a take-or-pay or minimum-throughput guarantee covering at least 2.5 Mt/yr, which converts the demand risk into contract risk.
- Phase A: build the berth structure but defer part of the reclamation and yard, cutting year-0 capex and preserving optionality.
- Present the board with a decision matrix showing NPV under low, central and high throughput, plus the discount-rate crossover, rather than a single number.
3. Evaluate the two tenders and advise the board, addressing both commercial and professional-practice obligations.
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What the numbers show.
- Bidder 1: 800,000 m³ × USD 41 = USD 32.8M for dredging, about 35% of a USD 93.7M total; the quay wall is priced correspondingly low.
- Bidder 2: 800,000 m³ × a balanced rate, say USD 30/m³ = USD 24.0M, with a total of USD 97.4M.
- On the face of the bids, Bidder 1 is cheaper by USD 3.7M.
Why the face value is misleading. In a re-measurable contract the authority pays for actual quantity. Bidder 1's dredging rate carries USD 13/m³ of excess over the estimate, so every additional cubic metre costs the authority 13/m³ more than it should. Break-even: 3.7M / 13 = about 285,000 m³, a 36% overrun. Dredging quantities on marine works routinely overrun by 10–30% because of ground conditions and siltation, and this project's own history shows a rising siltation trend. If the overrun reaches 30%, Bidder 1's cost advantage disappears entirely; at 50% the authority is significantly worse off. This is a classic mathematically unbalanced bid, and it transfers quantity risk to the employer at an inflated price.
Options for the authority.
- Evaluate both bids on a common risk-adjusted basis: engineer's estimate quantities plus ±25% and ±50% dredging sensitivity, and award on the risk-adjusted figure rather than the raw total.
- Require a rate breakdown for the dredging item before award and clarify any apparent error; do not silently adjust the bid.
- Cap the rate, or convert the dredging to a target-cost or provisional-sum item with a gain-share, or move to a design-build lump sum with defined ground conditions so quantity risk is properly allocated and priced.
- Check the quay wall rate for the mirror-image risk: if the quay wall quantity falls, Bidder 1 is protected and the authority is not.
Professional obligations.
- Evaluate every bid on the same basis and document the method before opening prices.
- Do not disclose Bidder 2's rates, and do not invite Bidder 1 to re-price after seeing the competition.
- If a bid contains an error, follow the stated clarification procedure and record the exchange.
- Advise the board in writing that the lowest total is not the lowest risk-adjusted cost, with the arithmetic attached.
Recommendation. Award to Bidder 2 unless Bidder 1's dredging rate can be brought to within about USD 31/m³ by clarification, in which case the price advantage is real. Given the authority's exposure to quantity growth and the thin 3.7M gap, the balanced tender is the better buy.