The method used to calculate net present value was based on five
estimated break
even sales figures
provided by the sources highlighted below (refer to Exhibit 1). Using Excel,
pre
production cash flows were
estimated at $900 million from the end of 1967
1971. Negative cash outflows based on estimated unit
production costs were calculated followed by re
venues starting in 1972 with each plane priced at $16 million
in all scenarios. From the end of 1971
1977, Lockheed planned to produce 210 Tri Star planes at an
average unit production cost of $14 million per aircraft with 35 planes per
year. Deposits equa
ling roughly
25% of the price of each aircraft were received two years previous to
delivery date.
At a 10% discount rate,
the net present value of future cash flows would be negative $584 million.
Exhibit 1
Despite industry analysts predicting 300 units
as Lockheed’s break
even sales point, at this level, net present
value remained insufficient to cover costs at negative $274 million. At 275
planes costing $3.5 million each,
the company achieved accounting breakeven at $962.5 million profit vs.
$960 mill
ion in development costs. If
the company had performed a true value break
even analysis, management would have realized that
roughly 400 Tri Star aircraft (about 67 per year for six years) costing
somewhere between $11.75 million
and $12 million per unit w
ould have to be sold in order to break even.
Based on the “learning curve” effect, production costs at levels above 300
would average lower than $14
million per unit. The assumptions for per unit costs are shown in the
following chart:
Exhibit 2
Given th
at the Tri Star project was riskier than the typical Lockheed operation, the
appropriate discount rate
would probably be higher than 10%. At an estimated 15% discount rate
(refer to Exhibit 3), break
even
sales would have occurred once the company sold 420
planes (70 per year for six years) costing $11.75
million per unit. Under a worst
case scenario at a 20% cost of capital, the firm would need to produce 636
aircraft at the same per unit cost (106 per year for six years). Considering
this information, it
is hardly
shocking that the company’s share price dropped 96% from 1967 to 1974
and that the project destroyed
shareholder value.
Source
Est. Production
Units
Est. Cost Per
Unit (in mill.)
NPV(10%)
Lockheed
210
$14
($584)
Lockheed
275
$12.50
($311)
Industry Analysts
300
$12.50
($274)
Actual Break-Even
402
$11.75
$47
Lucrative Project Scenario
500
$11
$436
The method used to calculate net present value was based on five
estimated break
even sales figures
provided by the sources highlighted below (refer to Exhibit 1). Using Excel,
pre
production cash flows were
estimated at $900 million from the end of 1967
1971. Negative cash outflows based on estimated unit
production costs were calculated followed by re
venues starting in 1972 with each plane priced at $16 million
in all scenarios. From the end of 1971
1977, Lockheed planned to produce 210 Tri Star planes at an
average unit production cost of $14 million per aircraft with 35 planes per
year. Deposits equa
ling roughly
25% of the price of each aircraft were received two years previous to
delivery date.
At a 10% discount rate,
the net present value of future cash flows would be negative $584 million.
Exhibit 1
Despite industry analysts predicting 300 units
as Lockheed’s break
even sales point, at this level, net present
value remained insufficient to cover costs at negative $274 million. At 275
planes costing $3.5 million each,
the company achieved accounting breakeven at $962.5 million profit vs.
$960 mill
ion in development costs. If
the company had performed a true value break
even analysis, management would have realized that
roughly 400 Tri Star aircraft (about 67 per year for six years) costing
somewhere between $11.75 million
and $12 million per unit w
ould have to be sold in order to break even.
Based on the “learning curve” effect, production costs at levels above 300
would average lower than $14
million per unit. The assumptions for per unit costs are shown in the
following chart:
Exhibit 2
Given th
at the Tri Star project was riskier than the typical Lockheed operation, the
appropriate discount rate
would probably be higher than 10%. At an estimated 15% discount rate
(refer to Exhibit 3), break
even
sales would have occurred once the company sold 420
planes (70 per year for six years) costing $11.75
million per unit. Under a worst
case scenario at a 20% cost of capital, the firm would need to produce 636
aircraft at the same per unit cost (106 per year for six years). Considering
this information, it
is hardly
shocking that the company’s share price dropped 96% from 1967 to 1974
and that the project destroyed
shareholder value.
Source
Est. Production
Units
Est. Cost Per
Unit (in mill.)
NPV(10%)
Lockheed
210
$14
($584)
Lockheed
275
$12.50
($311)
Industry Analysts
300
$12.50
($274)
Actual Break-Even
402
$11.75
$47
Lucrative Project Scenario
500
$11
$436