Rainbow Products - Part A

1. Rainbow Products - Part A.
k=
Time
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
12%
Cost
(35,000)
Savings
Additional
Outflows
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
NPV=
IRR=
MIRR=
Payback=
($946)
Total Net CF
(35,000)
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
PV of CF
(35,000.00)
4,464.29
3,985.97
3,558.90
3,177.59
2,837.13
2,533.16
2,261.75
2,019.42
1,803.05
1,609.87
1,437.38
1,283.38
1,145.87
1,023.10
913.48
check:
(945.68)
11.49%
11.80%
7 years
1. Rainbow Products - Part B.

Project is now a non-growing perpetuity with the following cash flows:
k=
12%
Additional
Time
Cost
Savings
Outflows
0
(35,000)
1
5,000
(500)
2
5,000
(500)
3
5,000
(500)
4
5,000
(500)
5
5,000
(500)
infinity
infinity
infinity
Total Net CF
PV of CF
(35,000)
(35,000.00)
4,500
4,017.86
4,500
3,587.37
4,500
3,203.01
4,500
2,859.83
4,500
2,553.42
infinity
infinity
Problem simplifies to NPV = {CF / (k - g)} - Cost; and when g=0, then NPV = {CF / k} - Cost
So, in our case, NPV = {4,500 / .12} - 35,000 =
$2,500
IRR =
12.86%
4%
Total Net CF
(35,000)
4,000
4,160
4,326
PV of CF
(35,000.00)
3,571.43
3,316.33
3,079.45
1. Rainbow Products - Part C.

Project is now a growing perpetuity with the following cash flows:
k=
12%
Additional
Time
Cost
Savings
Outflows
0
(35,000)
1
5,000
(1,000)
2
5,200
(1,040)
3
5,408
(1,082)
g=
4
5
infinity
5,624
(1,125)
5,849
(1,170)
infinity
infinity
4,499
2,859.49
4,679
2,655.24
infinity
infinity
Problem simplifies to NPV = {CF / (k - g)} - Cost; because savings and add'l outflows growing at 4%.
So, in our case, NPV = {4,000 / (.12 - .04)} - 35,000 =
2. Hot Dog Stand Options

Add Window
Update Equipment
Build New Stand
Rent New Stand
0
(75,000)
(50,000)
(125,000)
(1,000)
k=
1
44,000
23,000
70,000
12,000
15%
2
###
###
###
13,000
$15,000
IRR =
15.43%
3
44,000
23,000
70,000
14,000
NPV
$25,462
$2,514
$34,826
$28,470
IRR
34.6%
18.0%
31.2%
1207.6%
Choose the option that has the highest NPV (Build New Stand), NOT the highest IRR!
4. Valu-Added Industries, Inc. (VAI)

NPV = PV of Inflows - PV of Outflows = 210,000 - 110,000 =
$ 100,000
How Many Shares to Issue and at What Price?

MUST BE THAT Price = (Old Equity Value + New Project's NPV) / Old No. Shares O/S
So, P = (1,000,000 + 100,000) / 10,000 =
$
110 per share.
And, Q = New Project's Cost / New P =
1,000 shares.
Net Effect on Existing Shareholders = (New P / Old P) - 1 =
10%
5. Lockheed Tri Star Program (L-1011)

CF's presented below assume production of 210 planes:
k=
10%
Production
Year
Time
Investment
Costs
Revenues
1967
0
(100)
1968
1
(200)
1969
2
(200)
1970
3
(200)
140
1971
4
(200)
(490)
140
1972
5
(490)
560
1973
6
(490)
560
1974
7
(490)
560
1975
8
(490)
560
1976
9
(490)
420
1977
10
420
Undiscounted Totals:
(900)
(2,940)
3,360
NPV=
IRR=
($584)
Err:523
(in $ mil.)
Total Net CF
(100)
(200)
(200)
(60)
(550)
70
70
70
70
(70)
420
(480)
PV of CF
(100.00)
(181.82)
(165.29)
(45.08)
(375.66)
43.46
39.51
35.92
32.66
(29.69)
161.93
(584)
check:
(584.05)
MIRR=
Payback=
-0.98%
10 + years
CF's presented below assume production of 300 planes:

k=
10%
Production
Year
Time
Investment
Costs
Revenues
1967
0
(100)
1968
1
(200)
1969
2
(200)
1970
3
(200)
200
1971
4
(200)
(625)
200
1972
5
(625)
800
1973
6
(625)
800
1974
7
(625)
800
1975
8
(625)
800
1976
9
(625)
600
1977
10
600
(900)
(3,750)
4,800
(in $ mil.)
Total Net CF
(100)
(200)
(200)
(625)
175
175
175
175
(25)
600
150
PV of CF
(100.00)
(181.82)
(165.29)
(426.88)
108.66
98.78
89.80
81.64
(10.60)
231.33
(274)
check:
(274.38)
CF's presented below assume production of 420 planes and Production Costs = 12M / plane:
k=
10%
Production
(in $ mil.)
Year
Time
Investment
Costs
Revenues
Total Net CF
1967
0
(100)
(100)
1968
1
(200)
(200)
1969
2
(200)
(200)
1970
3
(200)
280
80
1971
4
(200)
(840)
280
(760)
1972
5
(840)
1,120
280
1973
6
(840)
1,120
280
1974
7
(840)
1,120
280
1975
8
(840)
1,120
280
1976
9
(840)
840
1977
10
840
840
(900)
(5,040)
6,720
780
PV of CF
(100.00)
(181.82)
(165.29)
60.11
(519.09)
173.86
158.05
143.68
130.62
323.86
24
NPV=
IRR=
MIRR=
Payback=
NPV=
IRR=
MIRR=
Payback=
($274)
2.38%
5.99%
9 + years
$24
check:
23.98
10.58%
10.27%
9 + years
So, Break-Even Point appears to be around 420 planes (which is more than total world market of 323!!).
Interestingly, decision to launch project in 1967 was disastrous, but things looked better in 1970:
k=
10%
Production
(in $ mil.)
Year
Time
Investment
Costs
Revenues
Total Net CF
PV of CF
1970
0
140
140
140.00
1971
1
(200)
(490)
140
(550)
(500.00)
1972
2
(490)
560
70
57.85
1973
3
(490)
560
70
52.59
1974
4
(490)
560
70
47.81
1975
5
(490)
560
70
43.46
1976
6
(490)
420
(70)
(39.51)
1977
7
420
420
215.53
(200)
(2,940)
3,360
220
18
NPV=
IRR=
MIRR=
Payback=
18
check:
11.42%
10.51%
#N/A + years
Thus, Lockheed was correct in pushing for loan guarantees from govt. once prior sunk costs ignored!!
17.73

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Rainbow Products - Part A

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1. Rainbow Products - Part A.

1. Rainbow Products - Part B.

1. Rainbow Products - Part C.

2. Hot Dog Stand Options

4. Valu-Added Industries, Inc. (VAI)

How Many Shares to Issue and at What Price?

Net Effect on Existing Shareholders = (New P / Old P) - 1 =

5. Lockheed Tri Star Program (L-1011)

CF's presented below assume production of 300 planes:

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