Graduate School of Business

Corporate Finance

Harvard Business Case

Investment Analysis and Tri Star Lockheed

1.

(A)

The payback is 35,000/5,000= 7 years

Computation of the NPV :

15

NPV= -35,000 + Σ 5,000 / ( 1 + 12%)^ 15

i=1

NPV = $- 947. 67

Computation of the IRR :

15

0= -35,000 + Σ 5,000 / ( 1 + IRR)^ 15

i=1

IRR= 11.49%

The NPV of this project is negative and the IRR is lower then the Cost of Capital (12%) Rainbow products shouldn’t go for it.

(B)

Based on the perpetuity formula we can compute the PV in this case :

Computation of the PV :

PV= Cash flow per year/ cost of capital)

=4,500 / 0.12

= $37,500

Computation of the NPV :

NPV= -Initial investment + PV

= -35,000 + 37,500

NPV=$2,500

Rainbow products could buy this machine with the service contract if they intent to use it in the long-run.

(C)

Computation of the PV :

PV= C/ k-g

In this case C (end of year perpetuity payout) = 5,000-1,000= $4,000 k= 12%, discount rate

g= 4%, growing rate at perpetuity

PV= 4,000 / (0.12-0.04) = $50,000

Computation of the NPV :

NPV= -35,000+ 50,000 = $15,000

The rainbow products company should invest in this project because its NPV is largely positive because of the reinvestment of 20% of the annual cost, even though this is in a very long term vision.

2.

•Computation of the IRRs (with financial calculator) :

Project,

-Add a New Window : IRR = 34.61%

-Update Existing Equipment : IRR = 18.01%

-Build a new stand : IRR = 31.20%

-Rent a larger stand: IRR = 1207%

All projects are acceptable because all the IRRs are higher than the discount rate(15%) Looking at the internal rate o return of each project, rent a larger stand Is the project with the highest IRR.

•Computation of the NPVs (with financial calculator) :

Project,

-Add a New Window : NPV = $ 25,461.9

-Update Existing Equipment : NPV = $ 2,514.18

-Build a new stand : NPV = $ 34,825.75

-Rent a larger stand: NPV = $ 28,469.87

All the projects are acceptable because all the NPVs are positive Looking at the net present value of each project, build a new stand Is the project with the highest NPV •The difference between the IRR and the NPV ranking is made by the scale of the investments, an investment of $1,000 here gives with an IRR of 1207% which is not enough to have an NPV of the first project with an initial investment of? $75,000

Even though the IRR of the project number 4 is largely superior to the one of The first project, the rule is to go for the project with the highest NPV. But still we could use $1000 for this project and generate a net present value of $ 28,469.87 and use the difference of $74,000 between the 2 projects and invest it another project that generate at least $ 7,000.

3.

A.In order to find the subsides for this project we first have to find the amount of yearly cash flow with the initial investment of $1,000,000 who will present an IRR of 25% with this formula.

4

0= -1,000,000+ Σ CF/ ( 1 + 25%)^ 4

i=1

…………

CF= 1,000,000/ 2.3603

CF= $ 42,3674.95

Subsidize= 423674.95- 371739 ( initial cash flow)

=$51,935.95

B.in order to have a two-year payback period with an initial investment of $1,000,000 we need two annual cash flow of $500000.

So, the subsidize= 500000-371739= $ 128,261

C.to compute the annual cash flows for this project we need to solve :

4

75000= -1,000,000+ Σ CF/ ( 1 + 20%)^ 4

i=1

…………

CF= 1075000/ 2.5849...