Investment Analysis and Lockheed Tristar

Rainbow Products

Part A
Cash Flow

-35000 5000 5000 5000 5000 5000 5000 5000 5000

Payback period 7 years

IRR 11.49%
NPV (Rs.945.68)
Decision NO WACC 12%

Part B
Cash Flow
Initial -35000
Yr 1 to infinity 4500

Payback period 7.78 years

IRR 12.86 %
NPV 2500 WACC 12%
Decision Yes

Part C
Cash Flow
-35000 4000 4160 4326.4 4499.456 4679.434 4866.612 5061.276 5263.727

Payback period 7.65 years

IRR 15.43 %
NPV 15000
Decision Yes
 5000 5000 5000 5000 5000 5000 5000

5474.276 5693.247 5920.977 6157.816 till infinity

Investment Analysis and Lockheed Tristar

Inv. CF yr 1 CF yr 2 CF yr 3 IRR
Add a new window -75000 44000 44000 44000 34.6%
Update existing equipment -50000 23000 23000 23000 18.0%
Build a new stand -125000 70000 70000 70000 31.2%
Rent a larger stand -1000 12000 13000 14000 1207.6%

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.
NPV@15%
$25,462
$2,514
$34,826
$28,470
Investment Analysis and Lockheed Tristar

CF 0 CF1 CF 2 CF 3 CF 4
Cash flows w/o subsidy -1000000 371739 371739 371739 371739

A) IRR 25% -877899 371739 371739 371739 371739

Cost to city 122101

PV of Cost to city @20% 122,101

B) 2-year Payback -1000000 371739 628261 371739 371739

Cost to city 256522

PV of Cost to city @20% 178140

C) NPV 75000 @20% -887334 371739 371739 371739 371739

Cost to city 112666

PV of Cost to city @20% 112,666

D) ARR 40% -1000000 371739 371739 371739 684783

Cost to city 313044

PV of Cost to city @20% 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

N*P = 110,000
and (10,000+N)*P = 1210,000 = total value of assets after the project

So, (10,000+N)/N = 11
or, 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 Cash Flow
1967 0 -100 -100
1968 1 -200 -200
1969 2 -200 -200
1970 3 -200 140 -60
1971 4 -200 -490 140 -550
1972 5 -490 560 70
1973 6 -490 560 70
1974 7 -490 560 70
1975 8 -490 560 70
1976 9 -490 420 -70
1977 10 -490 420 420
Total -900 -3430 3360 -480

Accounting profit -480

NPV @10% (Rs.584)

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 Cash Flow
1967 0 -100 -100
1968 1 -200 -200
1969 2 -200 -200
1970 3 -200 200 0
1971 4 -200 -625 200 -625
1972 5 -625 800 175
1973 6 -625 800 175
1974 7 -625 800 175
1975 8 -625 800 175
1976 9 -625 600 -25
1977 10 600 600
Total -900 -3750 4800 150

Accounting profit 150

NPV @10% (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 3 -200 268 68
1971 4 -200 -787 268 -719.25
1972 5 -787 1072 284.75
1973 6 -787 1072 284.75
1974 7 -787 1072 284.75
1975 8 -787 1064 276.75
1976 9 -764 804 40.25
1977 10 780 780
Total -900 -4700 6400 800

Accounting profit 800

NPV @10% 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 Cash Flow
1967 0
1968 1
1969 2
1970 3 140 140
1971 4 -200 -490 140 -550
1972 5 -490 560 70
1973 6 -490 560 70
1974 7 -490 560 70
1975 8 -490 560 70
1976 9 -490 420 -70
1977 10 -490 420 420
Total -200 -3430 3360 220

Accounting profit 220

NPV @10% Rs.16
11.74627