Analysis Tool
The amount and timing of contract financing has a direct impact on the cost to the Government and the financial outcome to the contractor as measured by the Internal Rate of Return (IRR) and Net Present Value (NPV) of the contract cash flows. The purpose of this tool is to demonstrate the financial impact to both the Government and the contractor of using PBPs versus customary progress payments.
As outlined in Mr. Assad’s Memorandum of April 27, 2011, SUBJ: Cash Flow Tool for Evaluating Alternative Finance Arrangements, this tool was developed to allow the contracting officer and industry to easily determine a Win-Win price that equitably accounts for the cost, benefits and potential risk associated with PBPs.
A Win-Win
PBPs offer a unique opportunity for a real "Win-Win" financial arrangement for the Government and the contractor. This opportunity presents itself due to the Government and the contractor having differing views of the time-value of money. The "Win" for the contractor is better cash flow resulting in a more favorable financial outcome as measured by the IRR and NPV of the cash flows at a reduced contract price.
The "Win" for the Government is a lower contract price that more than offsets the additional financing costs of providing a better cash flow to the contractor. The PBP Analysis Tool employs a discounted cash flow analysis to help the contracting officer to determine the Win-Win financial solution for any PBP arrangement. The tool provides a unique and simple to use “what if” feature on the timing of PBP event completion and payment that enables both sides to objectively assess the potential risk of PBPs in determining the Win-Win solution.
Progress Payments – the Benchmark
Customary progress payments are used as the benchmark for determining a Win-Win arrangement for several reasons. First, in Dr. Carter’s September 14, 2010 memo, he stated “I expect that the basis of negotiations shall be the use of customary progress payments. After agreement on price on the basis of customary progress payments, the contractor shall have the flexibility to propose an alternate payment arrangement for the Government’s consideration,” such as PBPs.
Second, progress payments are the financing method most commonly utilized between the Government and Industry. And third, progress payments are considered by industry to be a low-risk form of financing. For these reasons, the customary progress payment scenario is the right financial benchmark for a risk/reward analysis.
Downloading and Using the Tool
Version 4.0 of the tool is now available (the 4.0 version contains several changes that are explained in the tool itself). The tool allows the user to select between “New Award” and “Conversion”. The “New Award” option is the default selection that assumes the contract will be a new award using PBPs. The “Conversion” option is used when converting an on-going contract from progress payments or any other type of financing to PBPs. The tool uses XNPV and XIRR functions which are standard functions in Excel 2007 and later versions but are only contained in Microsoft's Analysis Toolpak on earlier versions. The steps needed to enable the Analysis Toolpak in Excel 97-2003 are under the "Important Notes" section of the Instructions – Basic tab.
Users should review the following six tabs within the tool before use:
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- Version Notes
- Instructions – Basic
- Instructions – Conversion
- Using the Model
- Assumption Explanations
- Data Input Sample