George Chang

FIN 322-02
Assignment 2
1. Rainbow Products Paint-Mixing Machine
A.

Equation View:

B.

Equation View:

Rainbow Products should only purchase the paint-mixing machine if they buy it
with the service contract. With the expected returns of only $5,000 for 15
years, the machine is not a profitable investment. This can be seen when
looking at the negative NPV in section A. The NPV in section B, however, is
positive. This indicates that with the machine returning $4,500 a year in
perpetuity, the investment will be profitable.
C.
Equation Given: V =
C = $5,000 (20% * $5,000) = $4,000
k = 12%
g = 4%
Equation Used: V =

= $50,000

NPV = V InitialInvestment
NPV = $50,000 + ($35,000) = $15,000
With the new proposal from Rainbow engineers, Rainbows Products should
purchase the paint-mixing machine and forgo the service contract. If they instead
reinvest the savings into the machine and grow their cash flows into the future, this
will provide the greatest return on investment. This can been seen when comparing
the NPV of part C with parts A and B. At a positive cash flow of $15,000, this plan is
by far the most profitable course.
2. Ballpark Stand

Equation View:

Based on IRR, I would recommend renting a larger stand. Based on NPV, I

would recommend building a new stand. I think the difference between the two
stems from what they aim to calculate, and the inputs they use. Because IRR is
looking for the rate of return when PV=0, I think it is less useful in this instance.
Instead, I would base my decision on NPV calculations. As such, I would recommend
building a new stand, because the increased future cash flows will result in the
greatest profit increase.
5. Lockheed Tri Star (equations attached at end)
At planned production of 210 planes:

If Lockheed only sells 210 planes, they will lose money on the Tri Star
program. This can be seen in the negative NPV of the proposed income from 210
planes.

At break-even of 300 planes:

Even if Lockheed were to sell 300 planes, their asserted break-even point,
they would not have actually broken even in value terms. This can be seen with the
NPV still being negative despite increased revenues.

True break-even point (Between 474 and 480 planes):

If Lockheed wished to break even in terms of value, they would need to sell
between 474 and 480 planes. The calculations above were made assuming the
same rules as before; an integer value for the number of planes sold (you cant sell .
4838 of a plane), and production spread evenly across the six years of active
production. Ignoring these rules could find you an NPV of exactly $0, but that
seemed unrealistic. Instead, it can be said that between 474 and 480 planes would
need to be sold.
The decision to pursue the Tri Star Program was a huge mistake. The program
led to big losses for Lockheed, and to avoid those losses, the company would had to
have sold an absolutely unreasonable number of planes. As stated in the case, the
market for wide-body planes over this time period ended up being about 323
aircraft. This means Lockheed would have had to capture 100% of new sales, plus
somehow create new growth in the air travel market. This is obviously impossible.
If Lockheed had properly estimated things like the growth of the market, their
ability to secure sales, and used NPV instead of accounting break-even, they would
have seen before the Tri Star Program even began that it was a losing proposition.
Instead they pursued it anyway, an unreasonable move.

The Tri Star program had a major effect on Lockheeds shareholders. The
losses incurred from the low sales of the Tri Star Program for multiple years in a row
led to a drop in the price of Lockheeds common stock from around $70 to just $3.
That is a decline in value of 95.71%. Additionally, with negative income Im sure any
plans for dividends were abandoned, meaning shareholders also lost that potential
source of income.