LOCKHEED TRI STAR CASE GROUP 6 640 UMASS DR GUPTA
• Maurice Bucknor
• Abdoulaye Camara
• Cynthia Martin
• Stavros Memtsoudis
• Sundeep Shukla
EXECUTIVE SUMMARY
In the mid 1960’s Lockheed decided to join the competitive, but growing market of commercial aircraft manufacturing. It enthusiastically introduced its plans for a wide-body aircraft, the TriStar, to rival products developed by Boeing and McDonnell Douglas. The TriStar had a range of almost 6340 miles and a speed of between 600-700mph6. However, the 400-passenger state-of-the-art plane started off very rocky, secondary to production delays and the staggering preproduction expenses of about $900 million dollars. After having based their planning on very optimistic assumptions including capturing 35-40% of the wide-body aircraft market, Lockheed found itself in need of additional funds, forcing it to seek government guarantees in order to appease lenders. In 1971, the company faced congressional hearings during which it became obvious that Lockheed had significantly miscalculated its strategy. In this case study analysis we retraced Lockheed’s assumptions in 1967 and calculated NPV given available cash flow information and the company’s plan to sell 210 units. This showed very clearly that even under these optimistic conditions, NPV was $ -585.1, thus suggesting that this project was not in the best interest of shareholders. Before Congress, Lockheed presented a revised accounting analysis of the break-even point was based on the assumption that at 275 planes would be sold (at a production cost of $12.5 million dollars and a sale price of $ 16 million dollars per unit). Under these circumstances the company claimed that it could generate $962.5 million dollars in profit. However, we found that even at the more conservative number of 300 units of production, NPV for the project was still negative at $-274.38 million dollars, thus suggesting non-profitability. In addition, there was a tremendous amount of sunk costs and additional needed capital that complicated things. We determined that the true-break-even-point required the production of 400 units at a production cost of $11.75 million dollars and a sale price of $16 million dollars, as evident by the positive NPV of $46.31Million. This miscalculation by Lockheed almost caused the company to go bankrupt and eroded shareholder value by almost 95% or $776 million dollars between 1967 and 1974. In summary, Lockheed embarked on the ambitious TriStar project with flawed analyses and unrealistic market expectations. Even when the company had to face the consequences of its decisions and petition congress for guarantees, it failed to complete a proper and realistic analysis of cash flows and ignoring sunk costs. This in turn was the reason for the almost catastrophic erosion in shareholder value. In addition, the Tri Star case shows the relevance of NPV, capital budgeting and forecasting in making business decisions.
INTRODUCTION/MOTIVATION
The 1960’s are widely viewed as the golden dawn of commercial aviation and the start of the jet age (1). With the projected increase in demand for the wide body aircraft, affiliated industries rushed to enter the market. In this context, Lockheed, the largest defense contractor in the US, in existence since 1912, joined the likes of Boeing and McDonnell-Douglas as a competitor in this arena (2). Although it had not produced a commercial aircraft for almost 10 years, the company planned to introduce the TriStar. The TriStar was a 400 passenger, wide-body aircraft, with a range of up to 6000 nautical miles, and powered by Rolls-Royce engines. From the beginning, a number of problems became obvious including engine and power plant development, setting the project back for a number of years (3). This and other difficulties lead to the accumulation of approximately $1 billion dollars in development expenses. With production beginning between 1968-1971 and having accumulated significant expenses, Lockheed faced an uphill battle. They also faced tough competition with others questioning the demand for the aircraft; and this led to Lockheed being on the brink of bankruptcy. This required Lockheed it to seek government-backed order guarantees in 1971 in order to secure additional bank loans (4). At that time, a congressional hearing and independent investigations exposed serious budgetary miscalculations putting the profitability of the project into question. Beyond the question “if the project ever had the chance of being profitable,” and “if not under what circumstances it could be”, came the ethical dilemma regarding the role of government in bailing out companies. Thus, due to Lockheed’s own miscalculations they brought additional hardships on themselves and significant failure. This was especially problematic as Lockheed had been the long-term preferred defense contractor for the government and had established itself as an industry leader in many avenues (5). In more recent times we have had bailouts of companies, schools, and organizations, which have been approved by legislators and been paid by taxpayers. Unfortunately there are sometimes less checks and balances in such situations. Many people were concerned that up to 60,000 jobs could be lost if the Tri Star project did not continue. While the discussion regarding the ethics of government bailouts is an important, in this analysis, we sought to analyze available data to determine: 1) if the TriStar project had a chance of profitability given original predictions regarding demand, cash flows and interest rates. 2) If profitability could be achieved given the revised data of increased demand and lower cost of production as suggested around the time of congressional hearings. 3) If the profitability could not be achieved under previous assumption, under what conditions the TriStar project could increase value to shareholders. 4) What impact the events between 1968 and 1971 had on shareholders.
DATA/ANALYSIS
The following paragraphs detail our approach to the four aspects of our analysis. 1) At planned (210) production levels, what was the true value of the Tri Star Program? Lockheed’s estimates were that they could break even after producing and selling between 195 and 205 units. In 1971, at the time of the Congressional hearings, Lockheed had orders for 103 units as well as options-to-buy for another 75 (i.e. in best case scenario sales of 178 units), expecting to sell many more. However, no net present value calculation including preproduction costs had been performed. The following information provided in the case presentation was used to calculate net present value for this project. NPV calculation and data used can be found in the Results section Table 1). We used the provided excel spreadsheet to compute the calculations. Calculations are based on the assumptions that 210 planes would be sold over 6 years (35 units/year). Cost of production per plane was $14 million dollars with a sale price of $16 million dollars. The assumed discount rate applied was 10%. As evident in the table, preproduction costs of $900 million dollars were accumulated. The production for these planes was planned between 1971 and 1977. In addition, the production cost was calculated to be at $490 million dollars per year (35U*$14 million dollars). Revenue was expected to be $ 560 million dollars per year (35U*$16Million), however deposits of $4 million dollars/plane (=$140 million dollars), which were received in year 1970 and 1970. 2) At a “break even” production of roughly 300 units, did Lockheed really break even in value terms? Lockheed claimed before the Congressional hearings that with a revised number of 275-units, the company could break even, while industry analysts suggested this number had to be about 300 airplanes. In order to test for this scenario (i.e. 300 units sold at 50 planes/year), we took into account potential savings in production due to the “learning curve effect,” resulting in a cost to produce of $12.5 million dollars/unit. With sale prices and discount rates remaining the same as in the original scenario, results in Table 2 details the cash flows. 3) At what sales volume did the Tri Star program reach true economic (as opposed to accounting) break even? Lockheed’s development costs in 1972 were estimated at $960 million dollars. Lockheed’s accounting analysis of the break-even point was based on the assumption that at a volume of 275 planes at a production cost of $12.5 million dollars and a sales price of 16 million dollars per unit, the company could generate $3.5 million dollars x 275units= $962.5 million dollars in profit to break even. Interestingly, using the accounting approach with the original plan of 210 planes at a profit of $2 million dollars for each unit, profits would have come to $420 million dollars, significantly less than half of the $960 million dollars spent in preproduction. Furthermore, a true value break-even analysis was not performed. In order to perform such an analysis, we estimated the cost of production at various volumes, taking into account the learning curve effect. This suggested that while the cost was 14 million dollars per plane at a volume of 210 units and $12.5 million dollars at 300 units, a further decrease in the number sold could lead to a cost of $11 million dollars for 500 units (Table A).
TABLE A) Units Cost/Unit Primary assumption 210 14 Revised assumption 300 12.5 High volume assumptiont 500 11 Taking this information and applying the learning curve effect, we constructed a table linking production volumes proportionately to production costs (Table B).
TABLE B) Units Cost/Unit 300 12.5 350 12.125 400 11.75 450 11.375 500 11 We then performed NPV calculations at every increment of 50 Units at the corresponding production costs (i.e 350, 400, 450). It appears that approximately 400 units needed to produced for the NPV to become positive. However, given the optimistic overall demand of 775 aircraft in the following decade and a targeted market share of 35% to 40% (equating to 270 to 310 Lockheed aircraft), expecting to sell 400 planes does not seem feasible. 4) Was the decision to pursue the Tri Star program a reasonable one? What were the effect this project on Lockheed shareholders. The results of the above analyses were used and the market information at the time was used to answer this question. Lockheed’s assumptions were that the wide-body industry would be growing at a 10% and Lockheed could capture 35 to 40%. To evaluate impact on shareholders we took into account the fall in share price from a high of $71 in 1967 to $3.25 in 1974. The number of outstanding shares and a market cap of $11.3 million dollars were used to calculate the value loss incurred by shareholders.
RESULTS: 1) Given the resulting cash flows and assumptions, the NPV at 210 units is -584.05. Thus, at the planned production levels the project was not profitable. See cash flows and calculations in Table 1.
TABLE 1) 2) Even at the revised production levels of 300 units, the NPV was -274.38, thus leading us to conclude that this project even under the revised assumptions was unprofitable (Table 2).
TABLE 2) 3) The tables below represent cash flows and resulting NPV analysis at various levels of production. Production of approximately 400 Units at a cost of $11.75 million dollars and sale price of $16 million dollars at a discount ate of 10%, yields a positive NPV, thus representing the approximate volume at which the project would seem profitable. 4) The decision to pursue this program was based on optimistic assumptions and failure to perform realistic and accurate calculations of net present value taking into account the extensive preproduction costs. The assumption that the industry would be growing at a 10% rate while in actuality it was closer to 5% and the idea that Lockheed could capture 30 to 40% of the market was very ambitious . This miscalculation led to huge erosion in shareholder value as evident by the decrease in share price from a high of $71 in 1967 to $3.25 in 1974. This represents an over 95 % drop. Given the number of outstanding shares of market cap of $11.3 million dollars, shareholders lost approximately $776 million dollars. From Jan 1967 to Jan 1971, share prices dropped from 64 to 11, this corresponds to a loss of approx $ 600 million dollars. Therefore, in both scenarios the drop in share value is bigger than NPV of -584Million.
CONCLUSION: This analysis underlines the conclusion that Lockheed’s TriStar project was not in the shareholders interest. Calculations of profitability were not computed appropriately, and the market for this aircraft was misjudged. Sunk costs were ignored and targets not met; which exemplified poor strategy. Thus, it is not surprising that Lockheed sold only 250 planes in total until the end of this project in 1981.
REFERENCES:
1) http://www.century-of-flight.net/Aviation%20history/airliners/2nd%20upload/timeline%2060s1.htm
****above link not working?
2) Wikipedia Contributors. “Lockheed L-1011 Tri Star”. Wikimedia Foundation. 21 March 2017 Web. Accessed 10 March 2017.
3)"Lockheed's Rough Ride with Rolls-Royce." Time. 15 February 1971 Web. Accessed 10 March 2017.
4) https://cdnc.ucr.edu/cgi-bin/cdnc?a=d&d=DS19710506.2.8 ****above link not working?
5) Wikipedia Contributors. ”Top 100 Contractors of the U. S. Federal Government.” Wikimedia Foundation. 25 February 2017. Accessed 10 March 2017.
6) Aircraft Wiki. Lockheed L-1011 Tri Star. Accessed 27 March 2017. http://aircraft.wikia.com/wiki/Lockheed_L-1011_Tristar
Rainbow Products Concession Stand MBA Tech Value Added Industries
RAINBOW PRODUCTS A)
CALCULATE NPV: -945.68
CALCULATE IRR: 11.49%
CALCULATE PAYBACK: 7 YEARS NPV: INITIAL INVESTMENT+ PV OF ANNUITY PV (.12, 15, -5000) -35000= -945.68
NPV IS NEGATIVE SO THIS PROJECT SHOULD BE REJECTED AND THEY SHOULD NOT BUY THE PAINT MIXING MACHINE
IRR: PROFIT/INVESTMENT -35000 + 5000/ (1+IRR)^15 =11.49%
PAYBACK: INITIAL COST/COST SAVINGS PER YEAR OR CASH FLOW 35000/5000= 7 YEARS
RAINBOW PRODUCTS B)
CALCULATE NPV: 2500 CALCULATE IRR: 12.86%
CALCULATE PAYBACK: 7.78 YEARS
NPV: INITIAL INVESTMENT+ PV OF ANNUITY PV= C/K-G -35000 +PV (.12, 1000, -4500) 4500/.12= $37,500 $37500- $35000 = $2500
SINCE NPV IS POSITIVE, RAINBOW SHOULD ACCEPT AND PURCAHSE WITH A SERVICE CONTRACT
IRR: PROFIT/INVESTMENT IRR VALUES: 12.86% PAYBACK:
INITIAL COST/COST SAVINGS PER YEAR OR CASH FLOW $35000/4500= 7.78 YEARS
RAINBOW PRODUCTS PART C
CALCULATE NPV: 15000
CALCULATE IRR: 15.43%
CALCULATE PAYBACK: 7.61 YEARS
NPV: INITIAL INVESTMENT+ PV OF ANNUITY PV= C/K-G -35000 + 50000 $15000
IRR: PROFIT/INVESTMENT
IRR VALUES: 15.43%
PAYBACK: $35000/4600 7.61 YEARS
RAINBOW SHOULD PICK OPTION C AS IT HAS THE HIGHEST NPV OUT OF ANY OF THE QUESTIONS. THUS, IT SHOULD ACCEPT THE OPTION TO ENHANCE THE CAPABILITY OF THE MACHINE OVER TIME.
Concession Stand Incremental Cash Flows Investments Year 1 Year 2 Year 3 Discount Rate NPV IRR Projetcs Add New Window -75000 44000 44000 44000 0.15 $25,461.91 34.6% Update Existing Equipment -50000 23000 23000 23000 0.15 $2,514.18 18.0% Build a New Stand -125000 70000 70000 70000 0.15 $34,825.76 31.2% Rent a Larger Stand -1000 12000 13000 14000 0.15 $28,469.88 1207.6%
Best NPV Best IRR Based on the internal rate of return rule (IRR), the best proposal option is renting a larger stand. IRR of 1207.6%.
Based on the net present value (NPV) rule, the best proposal option will be to build a new stand. NPV at $34,825.76.
When evaluating a project, it is generally assumed that higher the value of these two parameters, the more profitable the investment is going to be. Both the instruments are made use of to indicate whether it is a good idea to invest in a particular project or series of projects over a period of time which is normally more than a year. The obvious difference is that IRR does not consider the discount rate while the NPV does. Among other differences is that IRR tells the company whether making investments on a project will generate the expected profits or not, while NPV tells the value of any project today and the estimated value of the same project after a few years taking into account inflation and some other factors. If this value is positive, the project can be undertaken, but if it is negative, it is better to discard the project.
1) What is the net value of the project? a. To calculate the NPV we use the formula NPV = present value of future cash flows - required investment.
i. Which would get us to the following: $210,000 - $110,000 = $100,000
2) How many shares of common stock must be issued (at what price) to raise the required capital.
a. We would need to raise a total of $110,000 by selling 1,100 shares at the common stock price at $100 per share
3) What is the effect of this new project on the value of the stock of the existing shareholders, if any?
a. There will always be a short-term negative effect from any stock with any move for internal or external investments which needs outside financing. It is a necessity in a company to remove themselves from stagnation and investments is one of the best ways. In the short term, the stock will become “diluted” from the increase shares however, when they shareholders start to see the results of their investments the amount of money (also EPS) they hold within the company will increase greatly.
• Maurice Bucknor
• Abdoulaye Camara
• Cynthia Martin
• Stavros Memtsoudis
• Sundeep Shukla
EXECUTIVE SUMMARY
In the mid 1960’s Lockheed decided to join the competitive, but growing market of commercial aircraft manufacturing. It enthusiastically introduced its plans for a wide-body aircraft, the TriStar, to rival products developed by Boeing and McDonnell Douglas. The TriStar had a range of almost 6340 miles and a speed of between 600-700mph6. However, the 400-passenger state-of-the-art plane started off very rocky, secondary to production delays and the staggering preproduction expenses of about $900 million dollars. After having based their planning on very optimistic assumptions including capturing 35-40% of the wide-body aircraft market, Lockheed found itself in need of additional funds, forcing it to seek government guarantees in order to appease lenders. In 1971, the company faced congressional hearings during which it became obvious that Lockheed had significantly miscalculated its strategy. In this case study analysis we retraced Lockheed’s assumptions in 1967 and calculated NPV given available cash flow information and the company’s plan to sell 210 units. This showed very clearly that even under these optimistic conditions, NPV was $ -585.1, thus suggesting that this project was not in the best interest of shareholders. Before Congress, Lockheed presented a revised accounting analysis of the break-even point was based on the assumption that at 275 planes would be sold (at a production cost of $12.5 million dollars and a sale price of $ 16 million dollars per unit). Under these circumstances the company claimed that it could generate $962.5 million dollars in profit. However, we found that even at the more conservative number of 300 units of production, NPV for the project was still negative at $-274.38 million dollars, thus suggesting non-profitability. In addition, there was a tremendous amount of sunk costs and additional needed capital that complicated things. We determined that the true-break-even-point required the production of 400 units at a production cost of $11.75 million dollars and a sale price of $16 million dollars, as evident by the positive NPV of $46.31Million. This miscalculation by Lockheed almost caused the company to go bankrupt and eroded shareholder value by almost 95% or $776 million dollars between 1967 and 1974. In summary, Lockheed embarked on the ambitious TriStar project with flawed analyses and unrealistic market expectations. Even when the company had to face the consequences of its decisions and petition congress for guarantees, it failed to complete a proper and realistic analysis of cash flows and ignoring sunk costs. This in turn was the reason for the almost catastrophic erosion in shareholder value. In addition, the Tri Star case shows the relevance of NPV, capital budgeting and forecasting in making business decisions.
INTRODUCTION/MOTIVATION
The 1960’s are widely viewed as the golden dawn of commercial aviation and the start of the jet age (1). With the projected increase in demand for the wide body aircraft, affiliated industries rushed to enter the market. In this context, Lockheed, the largest defense contractor in the US, in existence since 1912, joined the likes of Boeing and McDonnell-Douglas as a competitor in this arena (2). Although it had not produced a commercial aircraft for almost 10 years, the company planned to introduce the TriStar. The TriStar was a 400 passenger, wide-body aircraft, with a range of up to 6000 nautical miles, and powered by Rolls-Royce engines. From the beginning, a number of problems became obvious including engine and power plant development, setting the project back for a number of years (3). This and other difficulties lead to the accumulation of approximately $1 billion dollars in development expenses. With production beginning between 1968-1971 and having accumulated significant expenses, Lockheed faced an uphill battle. They also faced tough competition with others questioning the demand for the aircraft; and this led to Lockheed being on the brink of bankruptcy. This required Lockheed it to seek government-backed order guarantees in 1971 in order to secure additional bank loans (4). At that time, a congressional hearing and independent investigations exposed serious budgetary miscalculations putting the profitability of the project into question. Beyond the question “if the project ever had the chance of being profitable,” and “if not under what circumstances it could be”, came the ethical dilemma regarding the role of government in bailing out companies. Thus, due to Lockheed’s own miscalculations they brought additional hardships on themselves and significant failure. This was especially problematic as Lockheed had been the long-term preferred defense contractor for the government and had established itself as an industry leader in many avenues (5). In more recent times we have had bailouts of companies, schools, and organizations, which have been approved by legislators and been paid by taxpayers. Unfortunately there are sometimes less checks and balances in such situations. Many people were concerned that up to 60,000 jobs could be lost if the Tri Star project did not continue. While the discussion regarding the ethics of government bailouts is an important, in this analysis, we sought to analyze available data to determine: 1) if the TriStar project had a chance of profitability given original predictions regarding demand, cash flows and interest rates. 2) If profitability could be achieved given the revised data of increased demand and lower cost of production as suggested around the time of congressional hearings. 3) If the profitability could not be achieved under previous assumption, under what conditions the TriStar project could increase value to shareholders. 4) What impact the events between 1968 and 1971 had on shareholders.
DATA/ANALYSIS
The following paragraphs detail our approach to the four aspects of our analysis. 1) At planned (210) production levels, what was the true value of the Tri Star Program? Lockheed’s estimates were that they could break even after producing and selling between 195 and 205 units. In 1971, at the time of the Congressional hearings, Lockheed had orders for 103 units as well as options-to-buy for another 75 (i.e. in best case scenario sales of 178 units), expecting to sell many more. However, no net present value calculation including preproduction costs had been performed. The following information provided in the case presentation was used to calculate net present value for this project. NPV calculation and data used can be found in the Results section Table 1). We used the provided excel spreadsheet to compute the calculations. Calculations are based on the assumptions that 210 planes would be sold over 6 years (35 units/year). Cost of production per plane was $14 million dollars with a sale price of $16 million dollars. The assumed discount rate applied was 10%. As evident in the table, preproduction costs of $900 million dollars were accumulated. The production for these planes was planned between 1971 and 1977. In addition, the production cost was calculated to be at $490 million dollars per year (35U*$14 million dollars). Revenue was expected to be $ 560 million dollars per year (35U*$16Million), however deposits of $4 million dollars/plane (=$140 million dollars), which were received in year 1970 and 1970. 2) At a “break even” production of roughly 300 units, did Lockheed really break even in value terms? Lockheed claimed before the Congressional hearings that with a revised number of 275-units, the company could break even, while industry analysts suggested this number had to be about 300 airplanes. In order to test for this scenario (i.e. 300 units sold at 50 planes/year), we took into account potential savings in production due to the “learning curve effect,” resulting in a cost to produce of $12.5 million dollars/unit. With sale prices and discount rates remaining the same as in the original scenario, results in Table 2 details the cash flows. 3) At what sales volume did the Tri Star program reach true economic (as opposed to accounting) break even? Lockheed’s development costs in 1972 were estimated at $960 million dollars. Lockheed’s accounting analysis of the break-even point was based on the assumption that at a volume of 275 planes at a production cost of $12.5 million dollars and a sales price of 16 million dollars per unit, the company could generate $3.5 million dollars x 275units= $962.5 million dollars in profit to break even. Interestingly, using the accounting approach with the original plan of 210 planes at a profit of $2 million dollars for each unit, profits would have come to $420 million dollars, significantly less than half of the $960 million dollars spent in preproduction. Furthermore, a true value break-even analysis was not performed. In order to perform such an analysis, we estimated the cost of production at various volumes, taking into account the learning curve effect. This suggested that while the cost was 14 million dollars per plane at a volume of 210 units and $12.5 million dollars at 300 units, a further decrease in the number sold could lead to a cost of $11 million dollars for 500 units (Table A).
TABLE A) Units Cost/Unit Primary assumption 210 14 Revised assumption 300 12.5 High volume assumptiont 500 11 Taking this information and applying the learning curve effect, we constructed a table linking production volumes proportionately to production costs (Table B).
TABLE B) Units Cost/Unit 300 12.5 350 12.125 400 11.75 450 11.375 500 11 We then performed NPV calculations at every increment of 50 Units at the corresponding production costs (i.e 350, 400, 450). It appears that approximately 400 units needed to produced for the NPV to become positive. However, given the optimistic overall demand of 775 aircraft in the following decade and a targeted market share of 35% to 40% (equating to 270 to 310 Lockheed aircraft), expecting to sell 400 planes does not seem feasible. 4) Was the decision to pursue the Tri Star program a reasonable one? What were the effect this project on Lockheed shareholders. The results of the above analyses were used and the market information at the time was used to answer this question. Lockheed’s assumptions were that the wide-body industry would be growing at a 10% and Lockheed could capture 35 to 40%. To evaluate impact on shareholders we took into account the fall in share price from a high of $71 in 1967 to $3.25 in 1974. The number of outstanding shares and a market cap of $11.3 million dollars were used to calculate the value loss incurred by shareholders.
RESULTS: 1) Given the resulting cash flows and assumptions, the NPV at 210 units is -584.05. Thus, at the planned production levels the project was not profitable. See cash flows and calculations in Table 1.
TABLE 1) 2) Even at the revised production levels of 300 units, the NPV was -274.38, thus leading us to conclude that this project even under the revised assumptions was unprofitable (Table 2).
TABLE 2) 3) The tables below represent cash flows and resulting NPV analysis at various levels of production. Production of approximately 400 Units at a cost of $11.75 million dollars and sale price of $16 million dollars at a discount ate of 10%, yields a positive NPV, thus representing the approximate volume at which the project would seem profitable. 4) The decision to pursue this program was based on optimistic assumptions and failure to perform realistic and accurate calculations of net present value taking into account the extensive preproduction costs. The assumption that the industry would be growing at a 10% rate while in actuality it was closer to 5% and the idea that Lockheed could capture 30 to 40% of the market was very ambitious . This miscalculation led to huge erosion in shareholder value as evident by the decrease in share price from a high of $71 in 1967 to $3.25 in 1974. This represents an over 95 % drop. Given the number of outstanding shares of market cap of $11.3 million dollars, shareholders lost approximately $776 million dollars. From Jan 1967 to Jan 1971, share prices dropped from 64 to 11, this corresponds to a loss of approx $ 600 million dollars. Therefore, in both scenarios the drop in share value is bigger than NPV of -584Million.
CONCLUSION: This analysis underlines the conclusion that Lockheed’s TriStar project was not in the shareholders interest. Calculations of profitability were not computed appropriately, and the market for this aircraft was misjudged. Sunk costs were ignored and targets not met; which exemplified poor strategy. Thus, it is not surprising that Lockheed sold only 250 planes in total until the end of this project in 1981.
REFERENCES:
1) http://www.century-of-flight.net/Aviation%20history/airliners/2nd%20upload/timeline%2060s1.htm
****above link not working?
2) Wikipedia Contributors. “Lockheed L-1011 Tri Star”. Wikimedia Foundation. 21 March 2017 Web. Accessed 10 March 2017.
3)"Lockheed's Rough Ride with Rolls-Royce." Time. 15 February 1971 Web. Accessed 10 March 2017.
4) https://cdnc.ucr.edu/cgi-bin/cdnc?a=d&d=DS19710506.2.8 ****above link not working?
5) Wikipedia Contributors. ”Top 100 Contractors of the U. S. Federal Government.” Wikimedia Foundation. 25 February 2017. Accessed 10 March 2017.
6) Aircraft Wiki. Lockheed L-1011 Tri Star. Accessed 27 March 2017. http://aircraft.wikia.com/wiki/Lockheed_L-1011_Tristar
Rainbow Products Concession Stand MBA Tech Value Added Industries
RAINBOW PRODUCTS A)
CALCULATE NPV: -945.68
CALCULATE IRR: 11.49%
CALCULATE PAYBACK: 7 YEARS NPV: INITIAL INVESTMENT+ PV OF ANNUITY PV (.12, 15, -5000) -35000= -945.68
NPV IS NEGATIVE SO THIS PROJECT SHOULD BE REJECTED AND THEY SHOULD NOT BUY THE PAINT MIXING MACHINE
IRR: PROFIT/INVESTMENT -35000 + 5000/ (1+IRR)^15 =11.49%
PAYBACK: INITIAL COST/COST SAVINGS PER YEAR OR CASH FLOW 35000/5000= 7 YEARS
RAINBOW PRODUCTS B)
CALCULATE NPV: 2500 CALCULATE IRR: 12.86%
CALCULATE PAYBACK: 7.78 YEARS
NPV: INITIAL INVESTMENT+ PV OF ANNUITY PV= C/K-G -35000 +PV (.12, 1000, -4500) 4500/.12= $37,500 $37500- $35000 = $2500
SINCE NPV IS POSITIVE, RAINBOW SHOULD ACCEPT AND PURCAHSE WITH A SERVICE CONTRACT
IRR: PROFIT/INVESTMENT IRR VALUES: 12.86% PAYBACK:
INITIAL COST/COST SAVINGS PER YEAR OR CASH FLOW $35000/4500= 7.78 YEARS
RAINBOW PRODUCTS PART C
CALCULATE NPV: 15000
CALCULATE IRR: 15.43%
CALCULATE PAYBACK: 7.61 YEARS
NPV: INITIAL INVESTMENT+ PV OF ANNUITY PV= C/K-G -35000 + 50000 $15000
IRR: PROFIT/INVESTMENT
IRR VALUES: 15.43%
PAYBACK: $35000/4600 7.61 YEARS
RAINBOW SHOULD PICK OPTION C AS IT HAS THE HIGHEST NPV OUT OF ANY OF THE QUESTIONS. THUS, IT SHOULD ACCEPT THE OPTION TO ENHANCE THE CAPABILITY OF THE MACHINE OVER TIME.
Concession Stand Incremental Cash Flows Investments Year 1 Year 2 Year 3 Discount Rate NPV IRR Projetcs Add New Window -75000 44000 44000 44000 0.15 $25,461.91 34.6% Update Existing Equipment -50000 23000 23000 23000 0.15 $2,514.18 18.0% Build a New Stand -125000 70000 70000 70000 0.15 $34,825.76 31.2% Rent a Larger Stand -1000 12000 13000 14000 0.15 $28,469.88 1207.6%
Best NPV Best IRR Based on the internal rate of return rule (IRR), the best proposal option is renting a larger stand. IRR of 1207.6%.
Based on the net present value (NPV) rule, the best proposal option will be to build a new stand. NPV at $34,825.76.
When evaluating a project, it is generally assumed that higher the value of these two parameters, the more profitable the investment is going to be. Both the instruments are made use of to indicate whether it is a good idea to invest in a particular project or series of projects over a period of time which is normally more than a year. The obvious difference is that IRR does not consider the discount rate while the NPV does. Among other differences is that IRR tells the company whether making investments on a project will generate the expected profits or not, while NPV tells the value of any project today and the estimated value of the same project after a few years taking into account inflation and some other factors. If this value is positive, the project can be undertaken, but if it is negative, it is better to discard the project.
1) What is the net value of the project? a. To calculate the NPV we use the formula NPV = present value of future cash flows - required investment.
i. Which would get us to the following: $210,000 - $110,000 = $100,000
2) How many shares of common stock must be issued (at what price) to raise the required capital.
a. We would need to raise a total of $110,000 by selling 1,100 shares at the common stock price at $100 per share
3) What is the effect of this new project on the value of the stock of the existing shareholders, if any?
a. There will always be a short-term negative effect from any stock with any move for internal or external investments which needs outside financing. It is a necessity in a company to remove themselves from stagnation and investments is one of the best ways. In the short term, the stock will become “diluted” from the increase shares however, when they shareholders start to see the results of their investments the amount of money (also EPS) they hold within the company will increase greatly.
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