Part 1: Recommendation
Lockheed should shut-down L-1011 project, exit commercial aircraft business, and focus on high-tech military aircraft.
Part 2: Rationale for Decision
Added later on July 18: (with numbers)
1) Estimate savings in dollars from withdrawal commercial aircraft.
2) Reinvest amount from #1 into the core business, which is high tech military planes. Provide ROA(pre Tri-star).
3) $200M @ROA of 13% =$26M Net Income. With the outstanding share, the EPS would be $2.30.
ROA=ROI. The Cost of capital is 10%, so it is safe to say the ROA should be 13%~14%.
V= CF/ (r-g)
Stock price (at 1967) $71= CF/ (0.1-0.03). 0.1 is the 10% of cost of capital. 0.03 is the maximum growth rate given any company. That gives CF is $4.97 per share.
After stock dropped (at 1974) $3.25= CF/ (0.1-0.03). CF is $0.23 per share.
SO if we are gonna exit TriStar, what will happen?
The reason why cashflow is suffering is because 3 estimate reason:
1) Commercial airplane couldn’t come sooner than they thought
2) Military contracts was stalling because technology issue
3) Classified secret project making some money
1) and 2) are losing the most money. All numbers are estimate.
1) Losing 0.12
2) Losing $0.05
3) Earning 0.4
Total in Cash flow $0.23.
After we get rid of 1) Commercial, we sell all equipment and department:
1) Saving and got some money $0.1
2) Grow to be 0.05
3) Grow to be 0.45
Total in CF= 0.60
Now CF=0.6, V=CF/ (r-g), r=0.1 and g=0.03, solve for V=$8.57. This how I can and should make the recommendation this way.
Another way to make a case is that, back in 1974, US was in Cold War with Russia. US aircraft were fly around the air border of Russian 24/7, in order to stay up in the air, they need tankers.
By 1960, when American Airline approached Lockheed to produce a competing commercial aircraft of Boeing 747, Lockheed already had a chance to observe how well Boeing 747 was doing in commercial use and its market share. In addition, McDonnell Douglas was developing DC-10, another competing commercial aircraft. American Airline’s purpose of approaching Lockheed was partially used it to pressure McDonnell Douglas to drop its price of aircraft, which they did. My rationale for decision was majorly based on the delayed entry of market and the lack of certainty in back order (needed 195 order to break even, only had 103 firm orders).
Part 3: Definition for Problem
1) Cost analysis doesn’t add up:
Given the calculation of NPV in cash outlays and future revenue, Lockheed’s analysts were overly optimistic and gave an understated number of aircraft sold in order to break-even.
2) Single source of engine supplier:
Lockheed should have given a major consideration the significance of having Rolls-Royce RB211 as the only engine. It is very risky, as Lockheed has no control over Rolls-Royce’s progress in making, nor its financial decisions. Lockheed set itself with