Lockheed L1011 Case Study, a Recommendation

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To: The Board of Directors

From: David F. Akin, Esq.

RE:Recommendation Regarding the Tri Start Wide-body Aircraft Project

Date: 1971 early 72ish

Recommendation:

The L-1011 project should be canceled.

Cancelling the L-1011 project will increase shareholder value by $161.92 per share. Excluding preproduction sunk costs, including a cost of capital 16%, and sales of 113 units and a per unit sales price of $16 million, the net present value (NPV) of continuing with the Tri Star is -$ 1,829,666,246.

Rationale for Decision:

Our original sales expectations were based on the assumption that we would capture 35% to 40% of the large body market. We further projected air travel growth of 10%. This would result in a potential market of 270 to 310 aircraft for our company. A more recent projection is a 5% growth rate in air travel or 323 aircraft. Assuming the Tri Star could capture 35%, we would expect sales of only 113 aircraft.

Definition of Problem
Lockheed’s stock value has plummeted to the point that the company’s survival is threatened. Recent $480 million losses on the C5-A, Cheyenne helicopter, the SRAM and nine Navy ship contracts and delays in getting the L-1011to market have created a negative cash flow. Based on more realistic projections of Tri Star sales, even with additional loan guarantees we would be borrowing to lose more money.

This leaves us with three options:
Do nothing and hope for the market for large body aircraft to accelerate rapidly and assume that the Fed will bail us out if it does not. This would also require Rolls Royce to get financing to meet its obligations to us on engine production at no additional cost to Lockheed. While it is hard to ignore the $900 million invested in preproduction costs, the economic, travel and political climate has changed dramatically. Doing nothing is no option.

Another option is to look for a military opportunity for refueling planes as was seen with the needs of the B-52 Bomber. The gains made in missile technology are making reliance on long-range bombers a less dependable source of sales. The eventual end of the Vietnam War will create a public demand for a peace dividend to be spent on domestic programs. We can hope another President from Texas will come along and start another ten-year war, but surely the lessons of Vietnam will not be forgotten. We see no reason to believe the market for air tankers is sufficient to change our recommendation.

This takes us to the recommended option, get rid of the Tri Star project.

Discussion and Analysis

Our sole supplier of engines, Roll Royce, will go into bankruptcy without a bailout from the Crown. It determined that it would cost twice the price we are paying them to meet their obligation. This would take us from having planes we cannot sell to having planes without engines we cannot sell. The problem at Rolls Royce is similar to our loss on the C5-A, where we entered into a fixed price contract and costs were much higher than anticipated. If Rolls-Royce is rescued by the British Government, after a bankruptcy filing, existing contracts can be set aside or modified. Lockheed should anticipate a significant increase in the cost of engines for the Tri Star.

The political climate is changing as well. We cannot forever expect a White House and Congress that we can count on to have the taxpayers subsidize mistakes. One need look no further than Congress cutting off funding for the SST, in spite of strong support from President Nixon. The Space Program is winding down, as well as the Vietnam War. We may not have long-term and lucrative guaranteed profits on military projects to cover our losses on civilian projects.

International politics can influence the Tri Star project as well. The British Government is angry over resistance in the United States to its project with France to build an SST of its own and travel to and from the United States. If U.S. resistance...
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