Investment Analysis and Lockheed Tri Star Problem Sets
February 25, 2013

1a. The results of NPV, payback and IRR calculations are the following. For payback method, Rainbow Product will pay back the original investment costs after 7 years. Net Present Value is -$946 and IRR is 11.49%. Rainbow Products should not purchase the machine according to the results of NPV and IRR calculation. The net present value of purchasing this new equipment is negative, and the internal rate of return is less than the cost of capital; thus both calculations confirm that the investment will not provide additional value to the company. Of course the payback method shows that the instrument will have paid back the cost in 7 years but does not take into consideration discounting present values. 1b. If Rainbow accepts the “Good As New” service plan, net present value will be a positive $2,500 and IRR will be 12.86%, greater than the cost of capital. The investment would also pay back the cost in 8 years. Rainbow should purchase the machine under this service plan as it results in a positive net value and the internal rate of return is greater than the cost of capital. 1c. If Rainbow chooses the reinvestment option, net present value is $15,000 and IRR is 15.43%. Therefore, the best investment decision is to accept option C, where engineers reinvest 20% of the savings that help cash flows grow 4% in perpetuity. Figure 1 (applicable to question 1a~1c)

2. Using the IRR rule, I recommend renting a larger stand as it yields the greatest rate of return. Using the NPV rule, I recommend building a larger stand.
IRR rule can be misleading in this case as this problem is comparing 4 mutually exclusive projects and given the stats, IRR for one out of four of these projects yields a much higher value, but none of these IRR values take discounting rate into consideration. Therefore, NPV is a better method. Figure 2

3. The NPV of this project is $100,000. 1,100 shares of common...

...CASE 7: INVESTMENT ANALYSIS AND LOCKHEEDTRISTAR
INVESTMENT ANALYSIS QUESTION 1:
A) Payback, NPV, IRR: (35,000) 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000
1 (35,000)
2
3
4
5
6
7
8
5,000
5,000
5,000
5,000
5,000
5,000
5,000
9 Machine Cost Duration (years) Cash Flows Cost of capital Payback (years) 35000 15 5000 12% total cost annual cash flow
10
11
12
13
14
15
7
NPV IRR
present value of cash inflows - present value of cash outflows 3.07%
($9,073.04)
B) Should Rainbow Products purchase the machine with service contract? perpetuity annual receipt discount rate 4500 0.12 37,500
$37,500 - $35,000 = $2,500 Based on the perpetuity, Rainbow Products should purchase the machine with the service contract.
C)
�� =
�� �� − ��
V= 4,000 .12 - .04 4,000 0.08
$4,000 cash flow 12% cost of capital 4% growth rate 50,000
50,000 - 35,000 = 15,000 Rainbow Products should reinvest into new machine parts each year; by doing so, Rainbow Products will have a net present value of $15,000.
INVESTMENT ANALYSIS QUESTION 2:
Incremental Cash Flows Investment Year 1 Year 2 Year 3 ($75,000) 44,000 44,000 44,000
Project Add a New Window
IRR 35%
NPV 22,140.79
Update Existing Equipment Build a New Stand Rent a Larger Stand Discount Rate 15%
-50,000 -125,000 -1,000
23,000 70,000 12,000
23,000 70,000 13,000
23,000 70,000 14,000
18%...

...Harvard Business School
9-291-031
Rev. November 17, 1993
Investment Analysis and LockheedTriStar
1. Rainbow Products is considering the purchase of a paint-mixing machine to reduce labor costs. The savings are expected to result in additional cash flows to Rainbow of $5,000 per year. The machine costs $35,000 and is expected to last for 15 years. Rainbow has determined that the cost of capital for such an investment is 12%. [A] Compute the payback, net present value (NPV), and internal rate of return (IRR) for this machine. Should Rainbow purchase it? Assume that all cash flows (except the initial purchase) occur at the end of the year, and do not consider taxes. [B] For a $500 per year additional expenditure, Rainbow can get a “Good As New” service contract that essentially keeps the machine in new condition forever. Net of the cost of the service contract, the machine would then produce cash flows of $4,500 per year in perpetuity. Should Rainbow Products purchase the machine with the service contract? [C] Instead of the service contract, Rainbow engineers have devised a different option to preserve and actually enhance the capability of the machine over time. By reinvesting 20% of the annual cost savings back into new machine parts, the engineers can increase the cost savings at a 4% annual rate. For example, at the end of year one, 20% of the $5,000 cost savings ($1,000) is reinvested in the machine; the net cash flow...

...Investment Analysis and LockheedTriStar
Group effort
Total points: 100 (Course grade 25%)
This case comprises four serially numbered stand-alone problems and the fifth one appears with the title of LockheedTri-Star. You are required to offer your calculations of values as indicated below. In addition to the calculations, write a brief summary of your findings in about 100 words for each problem.
1) Rainbow Products 20 points
| Machine Purchase | Machine plus service contract | Enhanced Machine |
Payback period | 7 Years | 7.78 Years | 7.65 Years |
NPV | ($945.68) | $2,500.00 | $15,000.00 |
IRR | 11.49% | 12.86% | 15.43% |
Decision (Yes/No) | NO | YES | YES |
We would advise Rainbow Products to not purchase the paint-mixing equipment unless they decided take on the additional $500 per year expenditure to service the machine, or decided to reinvest 20% of the yearly cost savings back into new machine parts. Either of the last two options would benefit the company, unlike the first option, as they provide both a positive Net Present Value (NPV) and Internal Rate of Return (IRR) greater than the Cost of Capital. Although the last two options have longer Payback Periods than the first option, using Payback Period to make a determination in this example is not suitable because of the shortcomings of the method.
2) Concession Stand 20 points...

...Investment Analysis and LockheedTriStar
The Case is divided into 5 different mini Cases. Each case is about another scenario.
Case 1 is about a company called Rainbow Products. The company considers the purchase of a paint-mixing machine. The machine costs $35.000 but the company expects an annual saving of $5.000 additional cash flow. The machine is expected to last 15 years and the cost of capital is 12 %.
First I would calculate the NPV and the IRR. If the NPV is higher then the return on the capital market, the project is profitable. The IRR shows me the discount rate that puts the NPV to zero. It could also be explained as the break-even point.
Additionally the company could get a “Good As New” service contract for $500 a year. The machine would then produce cash flows of $4,500 per year.
I would again calculate the NPV with the new cash flow. If the NPV is higher then the return on the capital market I would recommend this project.
The last scenario of this case is that the engineers of Rainbow products found a way to enhance the capability of the machine over time. They should reinvest 20 % of the annual cost savings back into new machine parts. The saving rate is 4 %.
There for you should use a formula which is written in the case. After calculating with this formula, you should decide what to do.
Case 2 is about a concession stand that sells hot dogs, peanuts, popcorn and beer. There are three years left...

...LockheedTriStar Case Study
Introduction
By 1966, Lockheed had already invested almost $900 million in research and development of the TriStar L-1011 (Scott, 2010). By 1971, with over $1 billion in sunk costs, Lockheed was seeking a $250 million federal guarantee through a congressional hearing in order to complete the program. Lockheed presented their case as a liquidity issue caused by unrelated military contracts and assured that the TriStar program was economically sound (text).
Through net present value (NPV) calculations, break even breakdowns, and shareholder stock analysis based on a sales volume of 210 aircraft; this case study identifies flaws in the initial proposals presented by Lockheed in 1971.
Financial Analysis including tables, graphs and other Analysis
Table 1: Cash flow an NVP analysis
Net present value of this project is just over -$584 million
Table 2: Present Value factors and new present value based on varying discount rates
Chart 3: NPV vs. Discount Rate
Table 2: Breakeven analysis
Results and Analysis (and value added questions)
In 1971 Lockheed estimated a breakeven point somewhere between 195 and 205 aircraft even though they had only received 103 solid orders. Based on the numbers seen in table 3, at a unit price of $14 million the breakeven...

...1. Rainbow Products is considering the purchase of a paint-mixing machine in order to reduce labor costs. The savings are expected to provide the additional cash flows of $5,000 per year. The machine costs $35,000 and will last for 15 years. The cost of capital for this investment is 12%
a) The payback period of this project is 7 years. The sum of cash flows during the first seven years equal the initial investment. The net present value (NPV) and IRR of this project is -$945.68, and 11.49% respectively. As the project has negative NPV and the IRR is lower than the cost of capital, Rainbow should not purchase the machine.
b) If Rainbow pays additional $500 per year, Rainbow can get a service contract that keeps the machine in new condition forever. As a result, the net cash flows per year would be $4,500. The NPV of this project can be calculated as follows.
NPV = Initial cost + Present Value of All Cash Flows
= -$35,000 + (4,500/0.12)
= $2,500
In this case, Rainbow should purchase the machine with this service contract as the NPV of this investment is positive.
c) Instead of the service contract mentioned in b), Rainbow can reinvest 20% of the annual cost savings in new machine parts, resulting in the increase in cost saving at 4% annual rate. Additionally, as long as Rainbow reinvest at 20%, the cash flows will continue to grow at 4% in perpetuity.
Table 1 Net annual cost savings calculations
Description Year 0 Year 1 Year 2 Year 3 Year 4 …..
Annual Cost...

...Pre-Feasibility Study
FRESH FRUITS PROCESSING
(Kinnow)
Small and Medium Enterprise Development Authority
Government of Pakistan
www.smeda.org.pk
HEAD OFFICE LDA Plaza, 6th Floor, Egerton Road, Lahore Tel: (042) 111-111-456, Fax: (042) 6304926-7 helpdesk@smeda.org.pk
REGIONAL OFFICE PUNJAB 6th Floor, LDA Plaza, Egerton Road, Lahore. Tel: (042) 111-111-456 Fax: (042) 6304926-7 helpdesk@smeda.org.pk REGIONAL OFFICE SINDH 5TH Floor, Bahria Complex II, M.T. Khan Road, Karachi. Tel: (021) 111-111-456 Fax: (021) 5610572 helpdesk-khi@smeda.org.pk REGIONAL OFFICE NWFP Ground Floor State Life Building The Mall, Peshawar. Tel: (091) 9213046-47 Fax: (091) 286908 helpdesk-pew@smeda.org.pk REGIONAL OFFICE BALOCHISTAN Bungalow No. 15-A Chaman Housing Scheme Airport Road, Quetta. Tel: (081) 831623, 831702 Fax: (081) 831922 helpdesk-qta@smeda.org.pk
May, 2006
Pre-Feasibility Study
Fresh Fruits Processing (Kinnow)
DISCLAIMER
The purpose and scope of this information memorandum is to introduce the subject matter and provide a general idea and information on the said area. All the material included in this document is based on data/information gathered from various sources and is based on certain assumptions. Although, due care and diligence has been taken to compile this document, the contained information may vary due to any change in any of the concerned factors, and the actual results may differ substantially from the presented information. SMEDA does not assume...

...Case study: Investment Analysis and LockheedTriStar
MGMTS-2700
Professor Hamza Abdurezak
Harvard University
Yang Zhong
1> A. Payback, NPV, IRR, Should purchase or not?
Payback: $35,000/5000=7 year
NPV: =Co+ C1…..n/(1+i)^1….n
Co=-3,5000
CF1-CF15= 5,000; I= 12
Computing result is $-945.67
IRR: 11.49%
NPV is negative and IRR is lower 12% so reject the proposal.
B.
NPV: =Co+ C1…..n/(1+i)^1….n
NPV= -35000+(4500/.12)
=2500
NPV is positive so should purchase the machine.
C. NPV: =Co+ C1…..n/(1+i)^1….n
= -35,000(4000/(0.12-0.04))
=-35,000+50,000
=15,000
NPV is positive so rainbow should reinvest the cost saving into the machine annually.
2.
Cash Flow:
Investment Y1 Y2 Y3 IRR NPV@15%
1. -75k 44k 44k 44k 34.63% 25,461.91
2. -50k 23k 23k 23k 18.01% 2,514.18
3. -125k 70k 70k 70k 31.21% 34,825.76
4. - 1k 12k 13k 14k 1207.06% 28,469.88
5. -125k 67k 67k 67k 28.10% 27,976.08
1,Using IRR I recommend the (4)
2, Using NPV I recommend the proposal (3)
3,NPV is better!
The NPV method is better because it shows the most cash flow as the highest. Because the discount rate is 15%, it is building a new both is prioritized higher.
4.
1, NPV=PV-Investment
=210k-110k=100k
2. Assuming issue N shares when price is P.
N*P=110,000(1)
P=1,210,000/(10,000+N) (2)
Then computing the result
So N=1000...

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