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FINANCIAL DECISION

MAKING
LOCKHEED TRI STAR CASE STUDY
BY- ARWA KHERIWALA

which boasted a range of over 6. the “Tri Star”.000 miles with nearly 400 passengers and speeds of close to 600 mph. McDonnell Douglas and Airbus. a technological winner and might be the company’s ticket back to solvency. Lockheed sought to move into the lucrative civilian commercial aviation sector and compete with Boeing. They had already invested nearly $900 million in development costs. Lockheed began design and testing in 1966 on their entry.Introduction Highly regarded by the military. . Carried by state of the art Rolls Royce turbofan engines. the L-1011 was by all accounts.

• A valid estimate of the NPV of the Tri-Star project at a volume of 210 planes as of 1967 was -$584 M.Problem • The summer of 1971 found the once formidable company on the brink of disaster. This was clearly an unacceptable NPV. . Lockheed was in need of $250 million more to bring the plane to market. but its bankers would not commit without federal loan guarantees. Spokespersons for Lockheed claimed before Congress that the Tri-Star program was economically sound and that their problem was mere liquidity crisis. • The decision to invest in the Tri-Star project by forecasting the cash flow associated with the project for a volume of 210 planes. opposition to the guarantee focused on estimated break-even sales – the number of jets that would need to be sold for total revenue to cover all accumulated costs. However. Despite the nearly $1 billion in sunk costs.

The NPV at this rate was $117. .Analysis and Solution • A break-even analysis revealed that the project reached economic break-even with the production of 210 planes at $12.13 M. Also to reach the value break-even Tri-Star would have to produce about 400 planes at $11. • Tri-Star’s recommended strategy should be of having a product mix of both commercial and military markets to achieve positive accounting and economic outcomes.5 M per unit.5 M per unit but did not reach value break-even at that level of production.

Haloulakos • Appendix in Excel Sheet.com • www.Lockheed Case Study • Google Links • www.APPENDICES & REFERENCE LIST • High Flight by George A.com .slideshare.coursehero.

5 million at 300) from 1971-1976.• Pre-production costs estimated at $900 million incurred between 1967 and 1971. . • Discount rate of 10% & 13% per year. • Production costs of $14 million (at 210 units could decline to $12. • Total of 210 planes delivered from 1972-1977 • Revenues of $16 million per unit. 25% of revenue received 2 years in advance of delivery.

05 M r= 13% NPV= $-584.Lockheed TriStar Case Study Analysis • At Planned (210 Units) production levels .r=10% NPV= $-274.38 M r=10% NPV= $-329.96 M . did Lockheed really breakeven in value terms? .what was the true value of the Tri-Star program? .r= 10% NPV= $-584.40 M • At a break-even production of roughly 300 units.

40) .Appendix 1 Production @ 210 Units Lockheed Tri Star Federal Grant 250 Avg Production Cost 14 M Revenue per Aircraft 16 M Guaranted Sales 210 35 Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10 Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Investment (100) (200) (200) (200) (200) Cost 0 0 0 0 (490) (490) (490) (490) (490) (490) Revenue 420 420 420 420 420 420 Pre-Revenue 140 140 140 140 140 140 Cash Flow (100) (200) (200) (60) (550) 70 70 70 70 (70) 420 NPV @ 10% ($584.05) NPV @ 13% (584. Lockheed TriStar Case Study.

38) NPV @ 13% (329.26) .Appendix II Production @ 300 Units Lockheed Tri Star Federal Grant 250 Avg Production Cost 12. Lockheed TriStar Case Study.5 M Revenue per Aircraft 16 M Guaranted Sales 300 50 Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10 Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Investment (100) (200) (200) (200) (200) Cost 0 0 0 0 (625) (625) (625) (625) (625) (625) Revenue 600 600 600 600 600 600 Pre-Revenue 200 200 200 200 200 200 Cash Flow (100) (200) (200) 0 (625) 175 175 175 175 (25) 600 NPV @ 10% ($274.

• What were the effects of this project on the shareholders? -The common stock prices went down from $70 per share in 1967 to $ 3. it was not reasonable since NPV was negative at 10% as well as 13%. • Was the decision to pursue the Tri-Star program a reasonable one? -No. Lockheed TriStar Case Study Analysis • At what sales volume did the Tri-Star program reach the true economic ( as opposed to accounting ) break-even? -Tri-Star reached the true economic ( as opposed to accounting ) break-even at 400 Units. .25 in 1974.

00 66.00 Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10 Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Investment (100) (200) (200) (200) (200) Cost 0 0 0 0 (767) (767) (767) (767) (767) (767) Revenue 840 840 840 840 840 840 Pre-Revenue 280 280 280 280 280 280 Cash Flow (100) (200) (200) 80 (687) 353 353 353 353 73 840 NPV @ 10% $263. Lockheed TriStar Case Study.Appendix III Production @ 400 Units – Break-Even Point Lockheed Tri Star Federal Grant 250 Avg Production Cost 11.5 Revenue per Aircraft 16 M Guaranted Sales 400.94 NPV @ 13% 117.13 .67 266.67 800.67 1066.

24 (Jan 1974). If the proper analysis was completed. • The decision to pursue the Tri Star program was unreasonable and overly ambitious.Lockheed TriStar Case Study • It is clear that the decision by Lockheed to embark on the Tri Star program was not a reasonable one. . this project may have been terminated and the company could have invested its capital in a profitable investment that would have increased shareholder wealth. Lockheed’s share price plummeted from $64 (Jan 1967) to $3.

6 Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10 Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Investment (100) (200) (200) (200) (200) Cost 0 0 0 0 (917) (917) (917) (917) (917) (917) Revenue 1000 1000 1000 1000 1000 1000 Pre-Revenue 333 333 333 333 333 333 Cash Flow (100) (200) (200) 133 (783) 417 417 417 417 83 1000 NPV @ 10% $441.3 1332. Lockheed TriStar Case Study.0 83.Appendix IV Production @ 500 Units Lockheed Tri Star Federal Grant 250 Avg Production Cost 11 Revenue per Aircraft 16 M Guaranted Sales 500.80 .02 NPV @ 13% 260.8 999.

5M profit versus $960M in actual development costs known in 1970 • This more realistic breakeven level announced subsequent to the guarantees being granted.5M275 = $962. • NPV breakeven approximately 400 planes • Total free world market demand for wide-body aircraft approximately 323 planes • Optimistic estimate: total demand 775 and 40% of that is 310 • Lockheed share price • $64 Jan 1967 drops to $3.$12.25 Jan 1974 • ($64-$3.5M per plane • $3.3 Million shares)=-$599 Million • Compare to -$584 Million NPV . Lockheed TriStar Case Study Evaluation • Accounting breakeven approximately 275 planes • $16M .5M = $3.25)(11.

5 million profit vs. Lockheed TriStar Case Study Evaluation Appendix-V Cost Per unit Source Production Units ( $ in Millions) NPV ( 13%) Lockheed 210 14 M (584. .40) Industry analyst 300 12. $960 million in development costs.5 million each. net present value remained insufficient to cover costs at negative $ 329. at this level.13 Lucrative Project Scenario 500 11 M 260. management would have realized that roughly 400 Tri Star aircraft (about 67 per year for six years) costing somewhere between $11.26 million.80 Despite industry analysts prediction that 300 units as Lockheed’s break-even sales point. If the company had performed a true value break- even analysis.5 M (329. the company achieved accounting breakeven at $962.5 M 117.26) Actual Break-Even 400 11.5 million and $12 million per unit would have to be sold in order to break even. At 275 planes costing $3.

• The decision to pursue the Tri Star program was unreasonable and overly ambitious. it made history. as investors evidently more properly valued the project in the free market. If the proper analysis was completed. the decision resulted in Lockheed’s share price plummeting from $64 (Jan 1967) to $3.5 billion on the TriStar project and the experience buried them in commercial aerospace. • The Lockheed Tri Star was an unfortunate case of a loss so big. Instead. it is apparent the shareholders were poorly served. • Given flawed decision-making. . Their initial estimates to break-even proved to be extremely optimistic. “Lockheed lost $2.24 (Jan 1974). Based on the cost data presented. this project may have been terminated and the company could have invested its capital in a profitable investment that would have increased shareholder wealth.

Recommendation Solution Reasons for having Product-Mix • Stock price performance reflects the firms record in either adding or subtracting • Tri-Star’s recommended strategy should be having intrinsic value based on execution of capital a product mix of both commercial and military projects markets to achieve positive accounting and • Capital project yielding a positive NPV adds economic outcomes. • The stock price equation quantifying the benefit for finding a way to retain and convert Tri-Star into a financial winner: Target Price = Low + NPV per share . to a stock price while a negative NPV reduces a stock price • Tri-Star can yields a positive NPV by adding a product mix with positive value like the Hercules C130 which have lower growth but higher share of profits.

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