Lockheed Tristar Case Analysis

Investment Analysis and Lockheed Tristar Rainbow Products Part A Cash Flow -35000

5000

Payback period IRR NPV Decision

5000

5000

5000

5000

5000

11.49% (Rs.945.68) NO

WACC

12%

WACC

12%

-35000 4500

Payback period IRR NPV Decision

Payback period IRR NPV Decision

5000

7 years

Part B Cash Flow Initial Yr 1 to infinity

Part C Cash Flow -35000

5000

7.78 years 12.86 % 2500 Yes

4000

4160

4326.4 4499.456 4679.434 4866.612 5061.276 5263.727

7.65 years 15.43 % 15000 Yes

5000

5000

5000

5000

5000

5474.276 5693.247 5920.977 6157.816 till infinity

5000

5000

Investment Analysis and Lockheed Tristar

Add a new window Update existing equipment Build a new stand Rent a larger stand

Inv. -75000 -50000 -125000 -1000

CF yr 1 44000 23000 70000 12000

CF yr 2 44000 23000 70000 13000

a) IRR rule is misleading due to difference in size of investment. b) Using NPV rule, we recommend "Build a new stand". c) The difference in ranking is explained by the size of investment.

CF yr 3 44000 23000 70000 14000

IRR 34.6% 18.0% 31.2% 1207.6%

NPV@15% $25,462 $2,514 $34,826 $28,470

Investment Analysis and Lockheed Tristar

Cash flows w/o subsidy A) IRR 25% Cost to city PV of Cost to city @20% B) 2-year Payback Cost to city PV of Cost to city @20% C) NPV 75000 @20% Cost to city PV of Cost to city @20% D) ARR 40% Cost to city PV of Cost to city @20%

CF 0 -1000000

CF1 371739

CF 2 371739

CF 3 371739

CF 4 371739

-877899

371739

371739

371739

371739

371739

628261

371739

371739

122101 122,101 -1000000

256522 178140 -887334

371739

371739

371739

371739

371739

371739

371739

684783

112666 112,666 -1000000

313044 150966

NPV subsidy option (C) is least costly to the city.

Investment Analysis and Lockheed Tristar a) NPV of project = 210,000 - 110,000 = 100,000

Amount of new equity to be raised = 110,000 Suppose, N = no. of new shares to be issued P = final share price

and So, or,

N*P = 110,000 (10,000+N)*P = 1210,000 = total value of assets after the project (10,000+N)/N = 11 N = 1,000 P = $ 110

b) 1000 new shares to be issued @$110 c) The project increases the value of the stock of the existing shareholders by $10 (from $100 to $110)

Investment Analysis and Lockheed Tristar a) Prodn. Level = 210 units = 35 units per year for 6 years Prod. Cost = $14 mn per unit Sale price = $16 mn per unit Prodn Year t Inv Costs Rev 1967 0 -100 1968 1 -200 1969 2 -200 1970 3 -200 1971 4 -200 -490 1972 5 -490 1973 6 -490 1974 7 -490 1975 8 -490 1976 9 -490 1977 10 -490 Total -900 -3430 Accounting profit NPV @10% b) Prodn. Level = 300 units = 50 units per year for 6 years Prod. Cost = $12.5 mn per unit Sale price = $16 mn per unit Prodn Year t Inv Costs Rev 1967 0 -100 1968 1 -200 1969 2 -200 1970 3 -200 1971 4 -200 -625 1972 5 -625 1973 6 -625 1974 7 -625 1975 8 -625 1976 9 -625 1977 10 Total -900 -3750 Accounting profit NPV @10%

Cash Flow -100 -200 -200 -60 -550 70 70 70 70 -70 420 -480

140 140 560 560 560 560 420 420 3360 -480 (Rs.584)

Cash Flow

200 200 800 800 800 800 600 600 4800

-100 -200 -200 0 -625 175 175 175 175 -25 600 150

150 (Rs.274)

c) Prodn. Level = 400 units = 67 units per year for 5 years and 65 units in year 6 Prod. Cost = $11.75 mn per unit Sale price = $16 mn per unit Prodn Year t Inv Costs Rev Cash Flow 1967 0 -100 -100 1968 1 -200 -200 1969 2 -200 -200

1970 1971 1972 1973 1974 1975 1976 1977

3 4 5 6 7 8 9 10 Total

-200 -200

-900

-787 -787 -787 -787 -787 -764 -4700

Accounting profit NPV @10%

268 268 1072 1072 1072 1064 804 780 6400

68 -719.25 284.75 284.75 284.75 276.75 40.25 780 800

800 Rs.43

d) The decision to pursue the program was not sound. It affected the shareholder value adversely. e) Prodn. Level = 210 units = 35 units per year for 6 years Prod. Cost = $14 mn per unit Sale price = $16 mn per unit Govt. to bear the sunk cost of $700 mn till 1970. Prodn Year t Inv Costs Rev 1967 0 1968 1 1969 2 1970 3 1971 4 -200 -490 1972 5 -490 1973 6 -490 1974 7 -490 1975 8 -490 1976 9 -490 1977 10 -490 Total -200 -3430 Accounting profit NPV @10%

Cash Flow

140 140 560 560 560 560 420 420 3360 220 Rs.16

140 -550 70 70 70 70 -70 420 220

11.74627