Lockheed L1011 Case Study, a Recommendation Essay

3216 Words Apr 25th, 2013 13 Pages
To: The Board of Directors

From: David F. Akin, Esq.

RE: Recommendation Regarding the Tri Start Wide-body Aircraft Project

Date: 1971 early 72ish

Recommendation:

The L-1011 project should be canceled.

Cancelling the L-1011 project will increase shareholder value by $161.92 per share.
Excluding preproduction sunk costs, including a cost of capital 16%, and sales of 113 units and a per unit sales price of $16 million, the net present value (NPV) of continuing with the Tri Star is -$ 1,829,666,246.

Rationale for Decision:

Our original sales expectations were based on the assumption that we would capture 35% to 40% of the large body market. We further projected air travel growth of 10%. This would result in a
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This will also have an impact on the excellent employees on the project, but a company on edge of destruction has to make difficult choices.

Appendix 1 (Calculations)

Cost of Capital

Market interest rate 10%
Inflation Premium 01%
Risk Premium 02%
Litigation Premium 01%
Default risk premium 01%
Liquidity premium 01%
Total Interest Rate 16%

Current Shareholder Value
$3.00 per share X 11.3 million Shares = $33.9 million

Adjusted Sales Forecast
Global Market at 5% demand growth 323
Project Lockheed market share 35%
New sales projection 113

Adjusted Cost per Unit
Production Costs $2,940,000,000
Project Sales 113 Cost per unit $26,000,000
Sale Price per unit $16,000,000
Loss per unit $10,000,000

*Note the breakdown of fixed versus variable costs are not know. For purposes of this exercise assume production costs are the same.

Revenues
Price per plane $16,000,000
Units to be sold x 113
Sales revenue 1,808,000,000

Net Present Value
Revenues $1,110,333,754
Less Production Costs $2,940,000,000 NPV -$1,829,666,246

Added Share Holder Value
Savings from cancellation $1,829,666,246
Shares Outstanding 11, 300,000
Added value per share 161.92

Appendix 2 (Research and Additional Analysis)

Economic Outlook:
As of August 1971, both unemployment and inflation are rising quickly. The Nixon

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