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Investment Analysis and Lookheed Tri Star Case Study Solution

Investment Analysis And Lookheed Tri Star Case Study

Investment analysis and Lockheed Tri Star

  1. Rain bow products are considering the purchase of a paint-mixing machine to reduce labor costs. The saving are expected to results in additional cash flow to rainbow of 5000 per year. The machine costs $35000 and is expected to last for 15 years. Rainbow has determined that the cost of capital for such investment is 12%.
  2. Solution: additional cash flow= $5000

Machine cost = $35000

Life of machine = 15 years

Cost of capital = 12%

Payback period = cost of investment/annual cash flow

Payback period = 35000/5000 = 7 years

This show that amount of investment can be pay back in 7 years which is less than the life of machine so according to payback period we adopt this investment.

NPV = net cash flow* (1-(1+ cost of capital)^no of years)/cost of capital – investment

NPV = 5000*(1-(1+0.12)^-15)/0.12- 35000= -946

Negative NPV show that company should not accept the project due to negative impact of investment.

IRR is less than cost of capital, because the IRR must be consider when the NPV of the project should be zero but in some other case the IRR is not considerable.

  1. Solution: rainbow should not purchase the machine with the contract because it give more negative NPV which show that with this service purchasing is not beneficial for the company.
  2. Growing rate = 4%

Discount rate= 20%

Amount of perpetuity = $5000

Present value = amount of pertputity/ discount rate – growing rate

Present value = 31250

Npv= pv- investment= 31250-35000= -3750

So in this option again we get negative npv which show that this investment opportunity is not favorable for the company and company should not waste its money by investing such project.

  1. NPV of four projects: where discount rate is 15 %
  2. Add a new window: NPV = {R1/(1+i) +R2/(1+i)^2+R3/(1+i)^3}- investment

NPV = {44000/(1+0.15)+44000/(1+0.15)^2+44000/(1+0.15)^3- 75000

NPV = 25460

  1. Update existing equipment: NPV = {R1/(1+i) +R2/(1+i)^2+R3/(1+i)^3}- investment

NPV = {23000/(1+0.15)+23000/(1+0.15)^2+23000/(1+0.15)^3- 50000

NPV = 2513

  • Build a new stand:

NPV = {R1/(1+i) +R2/(1+i)^2+R3/(1+i)^3}- investment

NPV = {70000/ (1+0.15) +70000/ (1+0.15) ^2+70000/ (1+0.15) ^3- 125000

NPV = 34824

  1. Rent a larger stand:

NPV: {R1/ (1+i) +R2/(1+i)^2+R3/(1+i)^3}- investment

NPV = {12000/ (1+0.15) +13000/ (1+0.15) ^2+14000/ (1+0.15) ^3- 1000

NPV = 28468

After calculating the NPVs of all options we have to select that option which give maximum NPV. Build a new stand give us maximum NPV so we have to select that option.

  1. IRR of four projects:
  2. Add a new window:

IRR = 15%+npv@15 %/( +npv @ 15 %-( -npv@35%))*(35%-15%)

IRR = 0.15+25460/(25460+383)*0.20 = 34.7%

  1. Updating existing equipment:

IRR = 15%+npv@15 %/( +npv @ 15 %-( -npv@35%))*(35%-15%)

IRR = 15%+2513/(2513+10995)*20% =  18.7%

iii. Build a new stand:

IRR = 15%+npv@15 %/( +npv @ 15 %-( -npv@35%))*(35%-15%)

IRR = 15%+34824/(34824+6291)*20% = 31.9%

Iv: rent a larger stand:

IRR = 15%+npv@15 %/( +npv @ 15 %-( -npv@35%))*(35%-15%)

IRR = 15%+28468(28468-12711)*20% =51.1%

According to IRR lowest percentage option will be selected so company has to move towards updating the existing equipment.

In both methods, IRR and NPV, most suitable and most convenient method is NPV because it easy to calculate and provide a appropriate answers in any type of business, mostly managers concern with NPV while selecting any investment option for the company.

  1. Which of the four subsidy plans would be recommend to the city if the appropriate discount rate is 20%?
  2. Subsidize the project to bring its IRR to 25%: as we know the discount rate of MBAT is 20% so its IRR is higher than its discount rate which is consider not too much favorable for the city. Less IRR is most suitable in any investment. So City would not select that suggestion from the MBAT as subsidize by city . this IRR also show that at this rate the NPV of the project going to be zero which create no profit no loss situation for the company.
  3. Subsidize the project to provide a two year payback: with 20% discount rate,MBAT subsidize with two year pay back period which means that all payment clear in two years and after that company is freely completing its project this option may not be selected by company because its project is 4 years program with annual cash flow from the MBAT to city company. If the select payback period their amount will be return in two years which may or may not beneficial for city company.
  4. Subsidize the project to provide an NPV of $ 75000 when cash flow discounted at 20%: company not select this option because the actual npv of the project is higher than $75000 so it show a loss dealing for city company because company get less worth of project instead of original high value.
  5. Subsidize the project to provide an accounting rate of return of 40%. : this option may consider by company because its accounting return must be higher than discount rate. So it would be profitable for the company and they get high advantages in case of return. So city company has to select fourth option after subsidize the MBAT company.
  6. What is the net present value of the project?

Cost of investment = $110000

Cash flow of project = $210000

NPV = 210000-110000 = $100000 which is very good amount of net present value so company must adopt that new project and enhance the profitability of the project.

  1. how many shares of common stock must be issued to raise the required capital?

Required amount = $110000

Price of per share= $100 p.s

Number of shares that issued for the capital = 110000/100= 1100 shares are issued from common stock and at the previous price which give reasonable profit to company.

c.what is the effect of new project on the value of the stock of the existing shareholders, if any?

Ans. When company issue new shares to full fill the capital requirement , the earning is going to increase of the company and shareholders expect to increase their earning also .so project is profit generator for the company as given cash flow against investment is high so earning of existing shareholders must be increase with reasonable percentage.

  1. Forecasted cash flow of the project.
year 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976
Revenue(millions) 140 140 420 509 93 93 93 93 93 93
Production Costs(million) 100 200 200 200 200 98 98 98 98 98
Profit of company 40 -60 -220 309 -107 -5 -5 -5 -5 -5
Production margin 71.42% 142% 47.6% 39.29% 215% 105% 105% 105% 105% 105%
  1. What is the IRR of the project?

The IRR of the project is more than 10% of cost of capital of the company. Internal rate of return is describing the link with NPV with the projects. Simple is that IRR is not too much important measurement which any company considered in case of selection of projects. So mostly this measurement is not considered in the companies. Instead of this companies use npv measurements which help in providing better decision about the project. But IRR can be calculated with very technical market information.

iii. NPV of the project:

Year Cash flow Present value
1967 140/(1+0.10) 127
1968 140/(1+0.10)^2 115
1969 420/(1+0.10)^3 315
1970 509/(1+0.10)^4 348
1971 93/(1+0.10)^5 58
1972 93/(1+0.10)^6 52
1973 93/(1+0.10)^7 48
1974 93/(1+0.10)^8 43
1975 93/(1+0.10)^9 39
1976 93/(1+0.10)^10 36

Present value of project =1181million

Amount of investment = 250million

NPV = 1181-250 = 931million

Which show that project has high npv and this project is very much beneficial for the company. Basically, company cost of capital is very much favorable for the earnings of company so 10% cost of capital is enough earnings which can cover the expenses of company and also generate a high level of profit. Its NPV show that after taking long, its utilization is very much favorable for the company it can bear all its costs and expenses and also generate a high level of profit for the company.

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