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Understanding Risk and Return in Bidder’s EPC Price Using CAPM Concept

FEATURED PAPER 

Trian Hendro Asmoro, CCP, PMP

Aberdeen, UK
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Abstract

Projects are currently characterized by their complexity, size and intensified multiparty involvement. It is therefore difficult to meet between company’s and contractor’s expectations in terms of project objectives. Using different types of contracts, contractors may have different view that is reflected from their price.

In EPC contract that uses a concept of lump sum contract, price submitted by contractor is a promise of each contractor to deliver the project. Contractor will then face risk in executing the project, while in the same time they will have its potential return.

This paper describes behaviour of contractors in submitting price as part of bidding process using CAPM concept. It mathematically proves that risk and return will be going to the same way, e.g. high risk may have high return. It concludes that the price heavily relies on contractor’s experience and risk profile.

Keywords: Engineering Procurement Construction (EPC), Contract Price, Capital Asset Pricing Model (CAPM), Risk and Return

  1. Introduction

We have known that there is a strong relationship between risk and return, e.g. high risk will normally have high return, and low risk will normally have low return. The question then, how can we mathematically prove such a relationship? Particularly in the EPC bidding process where bidders (contractors) have to come up with the price after getting project’s scope of work, it is interesting to understand the bidder’s behaviour in seeing the project’s risk and translating it into the price as well as their potential return.

CAPM is a model from finance discipline that discusses about the capital market, company’s value and company’s cost of capital. In addition, it can be used to explore the optimum combination of an investment among portfolio of stocks and a risk-free asset. It has therefore become one of important finance models describing the relationship between risk and return. Hence, we will use CAPM theory to analyse the contractor’s price in the EPC bidding process.

  1. Contract and Bidding Process
  2. Contract

A contract between company and contractor represents a mutually binding agreement including its terms and conditions which obligates contractor to provide something of value (e.g., specified products, services, or results) to company, and the company to compensate monetary or other valuable thing to the contractor (PMI, 2013). It can be simple or complex reflecting the simplicity or complexity of the deliverables or required efforts.

There are two main types of contract, i.e. fixed price and cost reimbursable contract.

More…

To read entire paper (click here)

About the Author

pmwj26-sep2014-Asmoro-AUTHORTrian Hendro Asmoroflag-ukflag-indonesia

 

Jakarta, Indonesia

Aberdeen, United Kingdom

Trian Hendro Asmoro is an oil and gas professional with more than 8 years of experience in project management and cost engineering areas; from conceptual to executing projects as planning & cost engineer, pipeline project leader, project site engineer, and project coordinator. He is currently a senior cost engineer at PT Medco E&P Indonesia. Trian holds a bachelor degree in Industrial Engineering from the Institute of Technology Bandung (ITB), and a Magister Management (MM) in Strategic Finance from University of Paramadina, Indonesia. Trian is a Certified Cost Engineer/Professional (CCE/CCP) and Project Management Professional (PMP). He has published several professional papers in journals covering topics of project management, cost engineering and petroleum economics. He is now living in Aberdeen, Scotland, United Kingdom, pursuing his MSc in Petroleum, Energy Economics and Finance at the University of Aberdeen, supported by Indonesia Endowment Fund for Education (LPDP scholarship) of Indonesian Government. He can be contacted at trian.asmoro@gmail.com