Investment Analysis and Lockheed Tristar

Rainbow Products
Part A
Cash Flow
-35000

5000

Payback period
IRR
NPV
Decision

5000

5000

5000

5000

5000

11.49%
(Rs.945.68)
NO

WACC

12%

WACC

12%

-35000
4500

Payback period
IRR
NPV
Decision

Payback period
IRR
NPV
Decision

5000

7 years

Part B
Cash Flow
Initial
Yr 1 to infinity

Part C
Cash Flow
-35000

5000

7.78 years
12.86 %
2500
Yes

4000

4160

4326.4 4499.456 4679.434 4866.612 5061.276 5263.727

7.65 years
15.43 %
15000
Yes

5000

5000

5000

5000

5000

5474.276 5693.247 5920.977 6157.816 till infinity

5000

5000

Investment Analysis and Lockheed Tristar

Add a new window

Update existing equipment
Build a new stand
Rent a larger stand

Inv.
-75000
-50000
-125000
-1000

CF yr 1
44000
23000
70000
12000

CF yr 2
44000
23000
70000
13000

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.

CF yr 3
44000
23000
70000
14000

IRR
34.6%
18.0%
31.2%
1207.6%

NPV@15%
$25,462
$2,514
$34,826
$28,470

Investment Analysis and Lockheed Tristar

Cash flows w/o subsidy

A) IRR 25%
Cost to city
PV of Cost to city @20%
B) 2-year Payback
Cost to city
PV of Cost to city @20%
C) NPV 75000 @20%
Cost to city
PV of Cost to city @20%
D) ARR 40%
Cost to city
PV of Cost to city @20%

CF 0
-1000000

CF1
371739

CF 2
371739

CF 3
371739

CF 4
371739

-877899

371739

371739

371739

371739

371739

628261

371739

371739

122101
122,101
-1000000

256522
178140
-887334

371739

371739

371739

371739

371739

371739

371739

684783

112666
112,666
-1000000

313044
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

and
So,
or,

N*P = 110,000
(10,000+N)*P = 1210,000 = total value of assets after the project
(10,000+N)/N = 11
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
1967
0
-100
1968
1
-200
1969
2
-200
1970
3
-200
1971
4
-200
-490
1972
5
-490
1973
6
-490
1974
7
-490
1975
8
-490
1976
9
-490
1977
10
-490
Total
-900
-3430
Accounting profit
NPV @10%
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
1967
0
-100
1968
1
-200
1969
2
-200
1970
3
-200
1971
4
-200
-625
1972
5
-625
1973
6
-625
1974
7
-625
1975
8
-625
1976
9
-625
1977
10
Total
-900
-3750
Accounting profit
NPV @10%

Cash Flow
-100
-200
-200
-60
-550
70
70
70
70
-70
420
-480

140
140
560
560
560
560
420
420
3360
-480
(Rs.584)

Cash Flow

200
200
800
800
800
800
600
600
4800

-100
-200
-200
0
-625
175
175
175
175
-25
600
150

150
(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
1971
1972
1973
1974
1975
1976
1977

3
4
5
6
7
8
9
10
Total

-200
-200

-900

-787
-787
-787
-787
-787
-764
-4700

Accounting profit
NPV @10%

268
268
1072
1072
1072
1064
804
780
6400

68
-719.25
284.75
284.75
284.75
276.75
40.25
780
800

800
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
1967
0
1968
1
1969
2
1970
3
1971
4
-200
-490
1972
5
-490
1973
6
-490
1974
7
-490
1975
8
-490
1976
9
-490
1977
10
-490
Total
-200
-3430
Accounting profit
NPV @10%

Cash Flow

140
140
560
560
560
560
420
420
3360
220
Rs.16

140
-550
70
70
70
70
-70
420
220

11.74627