Reference no: EM133048614

Risk and Opportunity 

GBCWorld Design and Engineering is a large Canadianvertically integrated engineering firm, with expertise in largescale infrastructure projects, including public-private partnership (PPP) projects involving government departments and agencies. It has been a major player in North America and has ventured into consulting activities in other areas of the world. The firm was recently approached about executing a major tourism project, a green-powered luxury hotel east of Worcester, South Africa, about 350 kilometers beyond the Cape TownInternational Airport and Seaport. The project once complete will be valued at $35 million Cdn. In recent years, corruption has grown, crime has increased and contributed to social instability. Those harsh realities aside, the country has benefited from foreign investment, and GBCWorldperceives an opportunity to take on a complicated, profitable project in a region considered too risky by the firm's competitors. GBCWorldhas an excellent relationship with Canada's Export DevelopmentCorporation. The agency is viewed by many as a very progressive, dynamic, and innovative export credit organization that will go to great lengths to promote the success of Canadian businesses, including taking on the significant country and bank risk to do so, when warranted. While senior management GBCWorldare is willing to invest time to put a bid together, the company's board members are concerned by so many challenges. How they wonder, will GBCWorldprotect its interests and ensure excellent outcomes?

The Challenge

GBCWorld has done works in other parts of Africa but has usually been one of the supporting firms. This time, GBCWorldis the lead firm under a World Bank development program. They will work with a consortium of fourteen local South African construction and hospitality firms known asSAConsortia or"SACLtd".GBC will provide design, engineering, and construction services toSAC, several government agencies, and other firms involved in the project. Most of the firms in SAC tend to be smaller and have limited access to working capital. GBC will need to be flexible and creative in doing business with these partners/customers. The board of directors has engaged your team to provide some consulting with respect to identifying some risks and their mitigation options. You have been able to outline some preliminary risks to consider and must now present viable risk management options.

The Risks

The project is only partially funded through development monies, assets (the land and buildings) associated with the project may not be used to secure financing. Many of the firms in SAC will rely on generous and flexible credit terms from GBCWorld. Shortages of resources, staff, and materials can cause significant delays, in payment and delivery, and generate significant cost overruns; questionable business practices and outright corruption can be a serious risk, as can eruptions of violence due to social unrest. It is expected that phase 1 of the infrastructure project, which includes transportation links, site services, and core buildings, would ideally take about 24months to complete. The full project will take over 60 months to finish. The project financing will be denominated in U.S dollars. South Africa has been plagued by much corruption. It ranks 69thout of 180 countries on Transparency's Corruption Index. Violence is also a daily occurrence in parts of the country as political and tribal groups protest inequities and wrestle for control. Economically the country has stagnated and its currency, the Rand has been volatile and weakening against the U.S dollar. The banking sector has experienced several challenges. New entrants have increased competition and driven down the profitability of existing banks. Several domestic banks have encountered financial difficulty related to the Financial Crisis in 2007-2009and the pandemic. Historically, some of the firms that are part of SACand other customers of GBCWorld have had varying degrees of experience and success in projects of this size. GBCWorldhas have been unable to obtain adequate information on all of the local firms to substantiate their creditworthiness, financial strength, and reputation. In many cases, a credit will need to be extended to some of the SAC firms for both shorter periods such as 30 -60 days and longer periods of time upwards of 6 to 12 months. So far $2 million of preliminary assessments and design services have been provided to SACand another$9 million of accounts receivable in engineering and construction services generated by other recent projects are outstanding. They are experiencing delays in collecting several sales invoices and related receivables which have strained cash flow and created some concern amongst the CFO and the Finance Committee of the board. Do they wonder if now is the time to take on this significant new project amidst this financial uncertainty? Some of the component parts and equipment to be used in the project will be sourced from around the world and will be transported at great lengths overseas, in the air, and overland. The terrain near the project site is rough and difficult to transport and there have been some recent incidents of theft. The railroad and roadways between the seaport and airport and the construction site are antiquated and may need upgrading. Your general impression after having studied the proposed project is that nearly every business risk imaginable is represented, to some degree, in this opportunity but there is a great financial reward if it is completed successfully.

Risk Mitigation Considerations

Many of GBCWorld's management team are experienced consultants and engineers with successes in numerous high-risk markets, and understand that while the risks are many, effective strategic planning can maximize the potential for success in this endeavor. The GBCWorldboard members are somewhat less familiar with dealing with the realities of developing market projects and will therefore require strong assurances. Your assessment indicates that this opportunity is primarily about risk management and ensuring adequate financing and cash flow over the term of the project. GBCWorldand its board must take a holistic view of the situation and determine whether they have access to the necessary risk mitigation tools and whether the firm has the financial wherewithal to see the project through.

Question 1 (ANSWERED, NOT THIS ONE NEEDED) Utilizing concepts from our class lectures, identify and describe the various risks faced by GBCWorldin its project.

There are four risks that the GBCWorld will be facing during this project which are country, commercial, foreign exchange, and transportation risk. The first one is a country risk which is a combination of political and economic risk in the exporter or importers country that will cause economic instability because of financial crises, revolution, and civil unrest. GBCWorld is facing this risk because in recent years the importer's country has had an increasing number of crimes and the growth of corruption that will cause economic instability. This will cause GBCWorld to face problems like increasing costs in business operating, safety concerns, inflation, and an increase in the unemployment rate. Moreover, commercial risk refers to the risk of non-payment by the importer or the risk of non-performance by the exporter. GBCWrold is facing commercial risk because they cannot obtain adequate information on local firms to substantiate their creditworthiness, reputation, and financial strength. Also, credit will need to be extended for both long and short-term. These will increase the risk of GBCWorld not being paid will cause a loss or result in a stained cash flow that will cause a lot of problems for the company. In addition, foreign exchange risk is a risk that most companies will face during an international trade activity, this risk refers to a fluctuation in the exchange rate. GBCWorld will face some problems like not being paid on schedule because the importers might not want to pay more and hold on to pay, or they pay on the time when the exchange rate will benefit them that might cause GBCWorld to lose profit because of this. Lastly, transportation risk is a risk of goods being damaged, stolen, or lost while in transit. GBCWorld is facing this risk because some component parts and equipment that are needed for this project are sourced from around the world and there are incidents of thieves near the terrain of the project site. 

ACTUAL QUESTION:

After identifying and describing the various risks, explain the differences from the point of view of risks to GBCWorld between the four primary payment methods Open Account, Payment in Advance, Documentary Collections and Letters of Credit that could be employed to mitigate the risks identified in Question 1. Recommend and justify a payment method that addresses the most important risks.