LOCKHEED CASE

d. Provide cash flows and NPV analysis for the Tir star program at planned
production level of 210 units

Solution:

The cash flows and NPV analysis for the Tir star program are in the excel sheet.
Exhibit 1:

Discount rate considered for 210 plane is 10%

Fixed cash flow from 1967-71 cash outflows were $ 900 million.
Production cost is $ 490 million ($ 14 million per plane, 35 planes per year )
25 % of the plane cost was paid 2 years earlier as advance and rest on the delivery

C0 / ( 1 + r ) ^ t + C1 / ( 1 + r ) ^ t + + C10 / ( 1 + r ) ^ t

Thus, the net present value of future cash flows is found to be negative $584 million.












YEAR t
Non
production
cost
Manuf.
Cost
CASH
OUT Payment
ADV
payment CASH IN
CASH
FLOW FACTOR NPV
1966
1967 0 -100 0 -100 0 0 0 -100 1 -100
1968 1 -200 0 -200 0 0 0 -200 0.909091 -181.818
1969 2 -200 0 -200 0 0 0 -200 0.826446 -165.289
1970 3 -200 0 -200 0 140 140 -60 0.751315 -45.0789
1971 4 -200 -490 -690 0 140 140 -550 0.683013 -375.657
1972 5 0 -490 -490 420 140 560 70 0.620921 43.46449
1973 6 0 -490 -490 420 140 560 70 0.564474 39.51318
1974 7 0 -490 -490 420 140 560 70 0.513158 35.92107
1975 8 0 -490 -490 420 140 560 70 0.466507 32.65552
1976 9 0 -490 -490 420 420 -70 0.424098 -29.6868
1977 10 0 0 0 420 420 420 0.385543 161.9282

NPV -584.048



Provide cash flows and NPV analysis for the Tri star program if 300 units
were sold over a 6 year production period

Solution:

The cash flows and NPV analysis for the Tri star program are as attached in Excel


YEAR t
Non
production
cost Manuf. Cost
CASH
OUT Payment
ADV
payment CASH IN
CASH
FLOW FACTOR NPV
1966
1967 0 -100 0 -100 0 0 0 -100 1 -100
1968 1 -200 0 -200 0 0 0 -200 0.909091 -181.818
1969 2 -200 0 -200 0 0 0 -200 0.826446 -165.289
1970 3 -200 0 -200 0 200 200 0 0.751315 0
1971 4 -200 -625 -825 0 200 200 -625 0.683013 -426.883
1972 5 0 -625 -625 600 200 800 175 0.620921 108.6612
1973 6 0 -625 -625 600 200 800 175 0.564474 98.78294
1974 7 0 -625 -625 600 200 800 175 0.513158 89.80267
1975 8 0 -625 -625 600 200 800 175 0.466507 81.63879
1976 9 0 -625 -625 600 600 -25 0.424098 -10.6024
1977 10 0 0 0 600 600 600 0.385543 231.326

NPV -274.382

Calculations are done on 10% discount rate.


Fixed cost from year 1967-71 are $900 mn
Cost per plane is $ 12.5 million, based on learning curve, 50 planes per year as
300/6 is 50. Therefore Production cost per year for 50 planes is $ 625 million
Revenue: 25 % of the plane cost was paid 2 years earlier as advance and rest on the
delivery.
.
The NPV calculations are based on the formula:
C0 / ( 1 + r ) ^ t + C1 / ( 1 + r ) ^ t + + C10 / ( 1 + r ) ^ t

The net present value of future cash flows for 300 plane is found to be negative $274
million.












e. How did decision to pursue Tri star program affect shareholder value

Solution:

As per the data given, Lockheed had estimated NPV against different quantities as shown:

Estimated Production (Units) NPV @10%
210 ($584)
275 ($311)
300 (Predicted by Industry Analysts) ($274)

From above table we can see even at 300 units of production, NPV is still negative.

Also, the standard rate of 10% here is low compared with the risk involved in the
operation. Considering risk in business, the actual discount rate must be higher than 10%,
which implies the above predicted quantities should have been higher. For example, in the
table below, we can see at 20% discount rate, NPV is lower, hence more number of units
should be produced to offset the increase in rate.

Estimated Production (Units) NPV @10% NPV@20%
210 (182.27) (273.55)

No surprises, share value prices plummeted from $70 to $3 due to wrong estimation in
quantity and discount rates





















f. Should Lockheed have continued the Tri star program at the end of 1970?

Year End Index Cash Flow
1967 0 -$100
1968 1 -$200
1969 2 -$200
1970 3 -$200
1971 4 -$200


We can see from above that by the end of year 1970, there is already a negative cash
flow of 700. Hence Lockheed is advised to continue with the program. The caveat
here is Lockheed should calculate NPV at a higher discounted rate for quantity
estimations. Also the quantity produced should be higher. A comparative data is
shown below


Estimated Production (Units) NPV @10% NPV@20%
210 (182.27) (273.55)
500 229.90 15.77

We can see from above that how change in discount rate affects the NPV. Hence
sufficient cushion must be made in terms of quantity produced and discount rate







CF = -$700