Valuing Capital Investment Projects

$298-092$

Discount Rate

Experts estimated that the cost of capital applicable to Lockheed's cash flows $($prior to Tri Star$)$ was in the $9\%-10\%$ range. Since the Tri Star project was quite a bit riskier $($by any measure$)$ than the typical Lockheed operation, the appropriate discount rate was almost certainly higher than that. Thus, $10\%$ was a reasonable $($although possibly generous$)$ estimate of the appropriate discount rate to apply to the Tri Star program's cash flows.

Break$-$Even Revisited

In an August $1972$ Time magazine article, Lockheed $($after receiving government loan guarantees$)$ revised its break$-$even sales volume: $"[$Lockheed$]$ claims that it can get back its development costs $[$about $$960$ million$]$ and start making a profit by selling $275$ Tri Stars." $3$ Industry analysts had predicted this $($actually$,$ they had estimated $300$ units to be the breakeven volume$)$ even prior to the Congressional hearings. $4$ Based on a "learning curve" effect, production costs at these levels $($up to $300$ units$)$ would average only about $$12\mathrm{.}5$ million per unit, instead of $$14$ million as above. Had Lockheed been able to produce and sell as many as $500$ aircraft, this average cost figure might even have been as low as $$11$ million per aircraft.

A$.$ At originally planned production levels $(210$ units$),$ what would have been the estimated value of the Tri Star program as of the end of $1967?$

B$.$ At "break$-$even" production of roughly $300$ units, did Lockheed break even in terms of net present value?

C$.$ At what sales volume would the Tri Star program have reached true economic $($as opposed to accounting$)$ break$-$even?

D$.$ Was the decision to pursue the Tri Star program a reasonable one? What effects would you predict the adoption of the Tri Star program would have on shareholder value?