Yonsei University
Graduate School of Business

Corporate Finance

Harvard Business Case
Investment Analysis and Tri Star Lockheed

1.

(A)
The payback is 35,000/5,000= 7 years

Computation of the NPV :

15
NPV= -35,000 + Σ 5,000 / ( 1 + 12%)^ 15 i=1

NPV = $- 947. 67

Computation of the IRR : 15
0= -35,000 + Σ 5,000 / ( 1 + IRR)^ 15 i=1

IRR= 11.49%

The NPV of this project is negative and the IRR is lower then the Cost of Capital (12%)
Rainbow products shouldn’t go for it.

(B)

Based on the perpetuity formula we can compute the PV in this case :

Computation of the PV :

PV= Cash flow per year/ cost …show more content…

- At first, we need to discount fixed costs of production which are the preproduction costs of the project. We do not treat them as sunk costs because they are so central in this project. We need to discount the preproduction costs to the end of year 1967:

NPV = 100 + 200/1.11 + 200/1.12 + 200/1.13 + 200/1.14 = 733,9730893

When the production level is 300, each plane produced contributes 3,5 million to Lockheed. This can be calculated as 16 – 12,5 = 3,5. 16 is the sales price of one plane and 12,5 is the production cost, yielding a contribution margin of 3,5 million dollars.

Thus, the break-even point can be found from the following equation:

Fixed costs / contribution margin = 733,9730893 / 3,5 = 209,706… ~ 210 planes

However, if the production level was only 210 planes, Lockheed would not have a contribution margin of 3,5. Instead, the contribution margin would be just 2 because below the production level of 300 the production cost per unit is 14 million dollars. The correct break-even point would be 733,9730893 / 2 = 366,98… ~ 367 planes.

Therefore, Lockheed did not break even in value terms at a ”break-even” production of 300 units. We can verify this by comparing the net present values at the end of 1967 of both cash outflows