Best Choice Consulting Firm

108 Murray Street, Ottawa, K1N 5M6

February 12th, 2014
Mr. Eric Clark
101 Application Lane
Cupertino
California
Dear Mr. Clark,
Best Choice Consulting Firm has completed the analysis of your
companys opportunity to partake in Project OS-7 from your client. The
results presented in the appended report consider the need for
Appshop to act within their best interests, not exposing the company
to unnecessary risk but also to protect Appshop against competition
from other firms.
Based on your request, on decision tree analysis, present value
analysis and the use of the Monte Carlo simulation tool. It has been
concluded that Appshop should seek to take advantage of Alternative
2, as proposed by your client. We have conducted a weighted average
of profits for this alternative and have determined that its value is
$593,102. The second-best alternative is Alternative 3, with a weighted
profit of $520,590. We have considered the risk implied by all
alternatives in our analyses, and have placed value on Appshops
ability to successfully complete projects of this magnitude.
The appended report provides extensive details of the work conducted,
the analysis methodology, underlying assumptions and case sensitivity.
Should you have any questions, or require further information, please
do not hesitate to contact our firm.

Kind Regards,

Best Choice Consulting Firm

Presented by
Thanh Long Dinh (100949889)
John McIntosh (100954993)
Richelle Molaro (100961833)
Dalanda Moustet (100961315)

Presented to Professor Kumar

Wednesday, February 12th, 2014

Table of Contents
TABLE OF CONTENTS......................................................................3
EXECUTIVE SUMMARY....................................................................4
THE PROBLEM.................................................................................................. 5
METHODOLOGY................................................................................................. 6
ASSUMPTIONS................................................................................................... 6
ANALYSIS......................................................................................6
SENSITIVITY ANALYSIS...................................................................9

Executive Summary
Following the successful implementation of the Oracle financial system
to their client, Appshop, a consulting and application management company,
has been presented with the opportunity to contribute to a much larger
venture, Project OS-7. This chance will give Appshop the opportunity to work
with their client across all seven of their international locations, and could be
very lucrative for Appshop.
In order to acquire the contract, Appshop suggested a price, which was
rejected by the client. The client counter-offered two alternatives to
Appshops initial proposal but warned them that if they chose not to act on
either proposal they would open the contract up to bids from Appshops main
competitors. The first two alternatives offered reliable streams of income. The
third alternative implied the possibility that Appshop may not be successful in
their bid for the contract and therefore could cause them not to work on the
contract at all.
In order to evaluate which alternative Appshop should pursue, our team
from Best Choice Consulting Firm analyzed each alternative independently.
This analysis was completed through the use of decision trees, present value
calculations and the Monte Carlo simulation tool (for the third option).
Through these analyses, it has been determined that Appshop should
undertake Alternative 2. This will provide Appshop with a weighted average
of profits of $593,102, which seems to be the most promising outcome. We
are confident in Appshops ability to turn around projects of this magnitude
due to their past history and success and are willing to accept the risks that
this alternative proposes.
It is crucial to highlight the time-sensitive nature of this decision, as
Appshop would like to avoid that a RFP is submitted making them vulnerable
to their competitors. Appshop must be confident in our analysis regarding
their opportunity to acquire this contract, any hesitation could cause them to
lose time and lose the attention of their client.

The Problem
Appshop is a privately held consulting and application management
company that provides professional services to its clients. Appshop has
recently implemented the Oracle financial system to a major client whose
headquarters are located in Dallas, Texas. Pleased with Appshops work, the
client has given Appshop the opportunity to work on a much larger venture,
Project OS-7. Project OS-7 would involve the implementation of Oracle
products across all seven of the clients international locations.
Eric Clark, the director for the central region of Appshop, must estimate
the costs and expected revenues that Project OS-7 will engender. After
investing two weeks of time developing a strategy, scope, and timeline,
Clarks team has reached a consensus on the details of the proposal. The
team estimates that Project OS-7 would take 24 months to complete and
would require 1000 hours of work per month. With an hourly cost of $140 per
hour, Project OS-7 would cost $140,000 monthly. The team proposed
charging the client $175,000 per month, leaving Appshop with a contribution
margin of $35,000 every month, representing a present value of $789,700 for
the project.
Upon negotiating with the client, it was clear that the client was not
willing to agree to Appshops initial proposal, instead the client offered two
contractual alternatives. The first alternative would enable Appshop to
receive equal payments of $155,000 per month, reducing Appshops
originally projected contribution by $20,00 per month. The second alternative
that the client suggested would supply Appshop with guaranteed monthly
revenues of $125,000. Attached to this offer was the possibility of gaining a
$1,500,000 bonus given that the contract was complete, the work was
satisfactory and met performance benchmarks. Despite this contract,
Appshops costs remain static at $140,000 per month. Henceforth,
undertaking this alternative could subject Appshop to losses of $15,000 per
month until completion where it is estimated that Appshop would have a 70%
chance of receiving the bonus.
The client stipulated that, should Appshop be unwilling to commit to
one of their proposed alternatives, they would produce a Request for Proposal
(RFP) for Project OS-7. This RFP would provide the opportunity for Appshops
major competitors to bid on the project. In divulging this stipulation to
Appshop, the client created a third alternative wherein Appshop could place a
lower-than-original monthly bid and could enjoy the possibility of receiving a

gain-share of the savings incurred at the completion of the project. The

Appshop team considered the alternative; they believed that if they
submitted a bid for $150,000 per month, they would have a 45% chance of
winning the contract.
In summary, Appshop has three alternatives to consider for Project OS7. Going forward Appshop must carefully analyze each alternative and
determine the most logical course of action that will also be in the best
interests of their company.

Methodology
Appshop must analyze the three alternatives presented to them in order
to compare and determine which alternative is in their best interests. In order
to conduct this analysis the following methodology was followed:

Appshop must determine the total profit from each alternative (with
and without the performance bonuses).
Appshop must employ the use of the Monte Carlo simulation tool in
order to estimate the gain-share savings that would result from
Alternative 3.
Appshop must determine the weighted average of each alternative
considering the likelihood of being award the bonus in Alternative 2 and
the likelihood of being awarded the contract in Alternative 3.
They must evaluate all three alternatives giving special attention to the
risks and rewards associated with each option.
Appshop must make a decision in their best interests to maximize their
profits by not allowing blended revenues to fall below $150 per hour.

Assumptions
The following assumptions were made in order to properly evaluate all
alternatives:
- The costs are incurred at the end of each month
- The revenues are received at the end of each month
- The monthly interest rate is fixed at 0.5% and includes inflation
- All gains and bonuses are received at the end of the 24 month-period
- The blended revenue is the monthly average of revenue including
bonus receivables.

Analysis
The final decision on which alternative to choose should be based on
several different factors; the present value of future payments that Appshop
will receive, the probability of success or failure and the level of risk that
Appshop is willing to undertake. Each alternative that is available to Eric
Clark has been analyzed below taking into consideration the previously
mentioned decision factors.
Alternative 1
Undertaking this alternative will cause Appshop to incur a cost of
$140,000 per month and will generate a revenue of $155,000 per month,
which will give the company a net profit of $15,000 per month. As shown in
the table below, this alternative provides the company with a present value
of $338,443. It is worth noting that the profit resulting from this option is also
$ 338,443 because this alternative does not provide the opportunity for
Appshop to receive any bonuses.
Cost per
month
$140,000.
00

Revenue
per
month
$155,000.
00

Net Cash
flow

$15,000.00

Present Value
of profit

$338,442.99

Total
profit
$338,442.
99

Our analysis determines that Alternative 1 is the most secure option, there is
no risk involved as Appshop will not be dependent on receiving a bonus to
break even, nor will they run the risk of losing the RFP bid (55% probability
that this will happen). Appshop will be guaranteed this project at a set price,
and henceforth can predict their costs and revenues based on a set payout.
Alternative 2
With Alternative 2, Appshop would still disburse $140,000 per month,
but would only generate $125,000 per month, therefore incurring a net loss
of $15,000 per month. The present value of the net losses over a period of
24 month is $338,443. However, after this period, Appshop will have a 70%
of chance of earning a $1,500,000 bonus should the work be completed with
a commendable performance. Given the probability of additional income from
a bonus payment, the total profit generated by Alternative 2 would be
$593,102.
Cost per
month

Revenue
per
month

Net Cash
flow

Present Value
of profit

Present
value of
bonus

Total
Profit

$140,000.
00

$125,000.
00

$15,000.00

-$338,442.99

$1,330,778
.50

$593,10
1.96

Furthermore, Alternative 2 presents a level of risk that may prove

difficult for Appshop to ignore. This alternative will force them to operate
below cost, with the hope of receiving a bonus payment. Therefore,
Alternative 2 presents the hightest form of risk, because this is the only
situation where Appshop could lose money. If they receive a contract for
Alternative 2, and do not receive a bonus, Appshop stands to lose $338,443.
However, if they choose to pursue Alternative 2 and receive the bonus,
Appshop will gain $992,335.51.
Alternative 3
In this scenario, Appshop would be required to bid on the Request for
Proposal submitted by the client with a 45% success rate. Should Appshop
win the RFP, they will stand to earn $150,000 per month in addition to a gainshare reward based on the clients savings at the end of the 24-month period.
After running a Monte Carlo simulation for 500 000 iterations, we were able
to determine that the total profit would be $1,160,000.

Monte Carlo simulation for RFP Alternative 3

Expected Savings

One random
value
6561.673289

Average
7196.250351

Expected gain from savings

624.6693155

1049.654461

Expected total profit

Gain from savings + P.V.)

$779.83

$1,156.87
(Thousands of
dollars)

Note: Averaged based on 500,000

iterations.
In Alternative 3, if they do not receive the RFP, they will break even at
0 they will receive no gains but will not incur any losses. Alternative 3
presents a lower possibility of winning the bid, however the stakes are also
lower. If Appshop allows the contract to go to bid, and they lose the bid, they
will incur the opportunity cost of Alternative 1 and Alternative 2. Alternative 3
has a 55% chance of failure, that Appshop will lose the bid and the contract
will be awarded to the Big 4. However, there is also a reasonable chance of
8

receiving the contract, which is twinned with a higher reward than any other
alternative. In Alternative 3, Appshop has the possibility to share in the gains
of savings from the implementation of the contract. Based upon the value of
the savings, generated by the Monte Carlo simulation, Appshop could earn a
significant amount of gain-share revenue from this contract.
The decision tree for Appshop is outlined below, highlighting the
outcomes for all three alternatives.

Based on the analysis of the profits generated by each alternative and

the risk associated with each option, Eric Clark shoud choose Alternative 2 if
he seeks to maximise profits. As seen in the decision tree, Alternative 2
provides Appshop with a weighted average of profits of $593,102 while the
second highest is Alternative 3 with a weighted profit of $520,590.
Alternative 1 is not a weighted average because it is not associated with any
level of risk, however it will only impart a profit of $338,443 to Appshop. To
be profitable in Alternative 2, Appshop relies on reccieving the $1.5 million
bonus for satasifactory work and achieving benchmarks. We are confident in
Appshops ability to turn around projects of this magnitude due to their past
history and success and are willing to accept the risk that there is a 70%
chance of receiving the bonus.

Sensitivity Analysis
If Clarks specific incentive is to keep the blended revenue per hour
above $150, then the company will avoid Alternatives 2 and 3 because both
of these options have the potential of generating a blended revenue less
than $150. As shown in the decision tree, there is a 30% chance that the
company will not get the bonus, therefore causing a net loss in Alternative 2.
Furthermore, Alternative 2 will lead to a blended revenue of $183.98 per hour
if Appshop receives the bonus, but only $125 per hour if they do not. In
Alternative 3 there is also a 55% probability that Appshop will not win the bid
and therefore lose the contract. If Appshop wins the contract in Alternative 3
they will have a blended revenue of $191.27 per hour but if they are not
award the contract they will receive no payments. The only viable option that
remains is Alternative 1. In Alternative 1, Appshop will receive revenues of
$155 per hour. This revenue is above the required $150 per hour and has no
risk. In this situation, Eric Clark is risk adverse and wants to aviod any
situation where blended revenue may be below $150. Therefore, Alternative
1 remains the only choice that will ensure hourly revenues remain above
$150 per hour, and will be Clarks most secure choice.

10