Lockheed Martin Case Study

Part I - Introduction

        In this case study Lockheed Martin is looking for a loan from the banks to continue work on the L-1011 Tri Star Airbus program. Lockheed Martin needs to prove that the decision is economically sound and wouldn’t just result in a failed project.  They have hired us to determine whether or not their project is economically sound.  Lockheed Martin believes their problem is a liquidity crisis based off of outstanding military contracts. We have evaluated their case and will determine whether or not Lockheed Martin should continue the project or cease production.

Part II- Analysis

[pic 1]

We used multiple financial metrics to determine whether or not Locheed Martin should have gone through with the Tri Star program.  The metrics we used were: the number of units produced, the costs, and the revenues.  Given that information, we were about to calculate the operating cash flows of the project.  The cost per plane would vary based off of the number of planes being produced.  In the case, there are three potential production costs: $14 million, $12.5 million, and $11 million.  [pic 2]

Option 1: Production of 210 Planes

        For the first option, we assume that Lockheed is producing 35 planes per year for a production cost of $14 million per plane.  Given these operating cash flows would give us an NPV of -$584 million and an IRR of -9.09% for ten years.  While we assume a discount rate of 10%, yielding an NPV of less than 0 and an IRR less than 10% means that this option is not optimal for Lockheed.  In the figure 1.1. we see that the NPV profile is below 0 at each discount rate.  In figure 1.2. we can see the relationship between NPV and production costs. In order to keep the NPV above or equal to 0, Lockheed would have to keep production costs at or below $8 million.  It is not possible to keep costs this low while producing planes in the market.  Even if Lockheed could secure financial assistance from the government, it would not be able to financially recover from the costs of the project.

Option 2: Production of 310 Planes

        In Lockheed’s second option, he would be producing 310 planes. 52 planes would be produced per year. Because there is an increase in the output of planes produced (+33), the production cost of each plane would be reduced from $14 million as shown in option 1 to $12.5 million. Those cash flows would give us an NPV of -$256 with and IRR of 2.99 and a 10% discount rate. Although the production cost decreased, the NPV is -$256 which is less that 0 and the IRR is less than the discount rate. Thus, it would be in Lockheed’s best interest to discontinue the project.