Lockheed Tristar

Case Study 1: Investment Analysis & Lockheed Tri-Star

1. Rainbow Products is considering the purchase of a paint-mixing machine to reduce labor costs. The savings are expected to result in additional cash flows to rainbow of $5,000 per year. The machine costs $35,000 and is expected to last for 15 years. Rainbow has determined that the cost of capital for such an investment is 12%.

a. Compute the payback, net present value (NPV), and internal rate of return (IRR) for this machine. Should Rainbow purchase it? Assume that all cash flows (except the initial purchase) occur at the end of the year, and do not consider taxes.

Payback Period

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Net Present Value

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Internal Rate of Return

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We see from the graph that the IRR would be 11.49%. The net present value is -946$. The payback period is about 16 years.

Rainbow Products should not purchase this machine! Ignoring the payback period because it does not consider the opportunity cost, we see that NPV is negative, so the company is losing money with this investment! Also, the IRR is less than the discount rate, which is not good.

b. For a $500 per year additional expenditure, Rainbow can get a “Good as new” service contract that essentially keeps the machine in new condition forever. Net the cost of the service contract, the machine would then produce cash flows of $4,500 per year in perpetuity. Should Rainbow Products purchase the machine with the service contract?

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The payback period would increase since the annual net cash flow is less than before. Now the NPV is +$2,500. However, the IRR is about 9.6%, which still falls short of the opportunity cost, so I would still not recommend this project.

c. Instead of the service contract, Rainbow engineers have devised a different option to preserve and actually enhance the capability of the machine over time. By reinvesting 20% of the annual cost savings back into new...