Valuing capctsital Investment projects Case Solution

Thus, an additional 1100 number of outstanding common shares will be required at the price of $100 per share in order to invest in the new project (that would cost $110,000). It is concluded that with large amount of shares offered to different new shareholders, the profit on dividend will reflect less value as compared to the past value. The impact on existing shareholders will not befavourable to them and with the increasing number of shares, the company should decide to shrink the size of return on dividends in order to recover the cash outflows under the project. Therefore, it can be assumed that with large number of shares, the company may not provide exact profits to its existing shareholders and this can also be a threat to them in the future.

Question 4

Answer

Tri star program was introduced by Lockheed, an American aerospace company who was seeking to invest for the new aeroplanes in order to receive positive results. It had proposed the program to develop the estimated results for the upcoming future. The program showed that 210 planes will be produced every year for a cumulative five years of production. However, the report in the beginning of 1972 indicated that the company had not metthe necessary results as compared to the proposed project. Therefore, the Lockheed reviewed some of the results completed in the past years.

It had estimated that the true value of Tri star project before startingthe scenario will be 1,659,553,354as compared to the new present value incurred in the year 1972. At the breakeven point, Lockheed should produce at least 257 planes per year in order to meet the breakeven value if the estimated value will be 300 planes per year. In the case of 500 planes per year, the total production cost will be less than the cost in the 210 and 300 units respectively. Therefore, the company in that case should only produce 180 planes per year in order to show the breakeven point at the end of the year.

It has been analysed that the best option for the company to conduct the true economic breakeven is by producing at least the projected 500 planes in the cumulative years, which will allow to decrease the productions cost per unit to produce the plan and also increase the sales volume in order to recover the developmental cost.

The decision was quiet useful for the company to adopt because the demand for the planes washigh and customers wereexited to pay in advance in order to purchase the plans however,the market conditions were not favourable to Lockheed asthe competitors hadalready grabbed the market for the new planes. With so many predictionsto produce the plane, the best option for the company will be to produce unlimited planes asthe cost of production will decrease according to the size of the operations.

According to the demand of the aero industry, it will be quite favourable to the shareholders to participate in the program as well as they can enjoy high profit margins according to the mass production with huge sales volume. Therefore,the case shows that if the size of operations will be high to produce the planes with less cost of production, then it can be more profitable to the investors to receive high dividends for Lockheed, which will allow them to invest more for the better results in the futur

Exhibit 1

Free Cash Flows (Project A)
  year 1
EBIT 6667
Add: Depreciation 3333
Less Capital Expenditure 420
FCF 9580
WACC 10%
NPV at 10% $8,709
NPV at 35%  $7,096

Exhibit 2

Free Cash Flows (Project B)  
  Year 1 Year 2
EBIT 5834 5833.7
Add: Depreciation 3333 3333.3
Less Capital Expenditure 300 340
FCF 8867 8827
WACC 10% 35%
NPV at 10% $15,356  
NPV at 35%% $11,411  

Exhibit 3

Free Cash Flows (Project C)
  Year 1 Year 2 Year 3
EBIT 1112 2778 11112
Add: Depreciation 3333 3333 3333
Less Capital Expenditure 200 220 600
FCF 4245 5891 13845
WACC 10% 35%
NPV at 10% $19,130
NPV at 35%% $12,004

Exhibit 4

Free Cash Flows (Project D)
  Year 1 Year 2 Year 3
EBIT 11112 1112 -555
Add: Depreciation 3333 3333 3333
Less Capital Expenditure 600 200 100
FCF 13845 4245 2678
WACC 10% 35%
NPV at 10% $18,107
NPV at 35%% $13,673

……………….

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