Section 2 – RISK ANALYSIS

Question 3 

A contractor submits a bid on a project for which more research and development work needs to be done. It is estimated that the total cost of satisfying the project specifications will be £20million plus the cost of the further research and development work. The contractor views the cost of this additional work as a random variable with a mean of £4million and a standard deviation of £1million. The contractor wishes to submit a bid such that his expected profit will be 10% of his expected costs.

A) What should be the bid?

B) Simulate (with a min of 200 repetitions) the average and the standard deviation of net expected profit for a range of bids varying between £20million and £40million. Then discuss your findings.

C) Now assume the contractor knows that another contractor will place a competitive bid. Based on historical data, he knows the competitor’s bid has a normal distribution with mean £25million and standard deviation of £2million. The project will be assigned to the contractor placing the lowest bid. How does the distribution of net expected profit over the range of bids considered in part B) changes, when the competitor is taken into account?