Lockheed Tri Star Harvard Case Solution & Analysis

Introduction

The Rainbow Products Company is operating in the printing industry and currently the production of Rainbow Products is labor intensive, which require a high level of investment in labor cost due to increased wages. Therefore, the management of Rainbow Products is considering an investment opportunity to invest in new technology machinery that will reduce the labor cost that it currently incurs in order to continue its printing operations. However, Rainbow Products' management has three alternative investment opportunities that will reduce the required level of the labor force, meanwhile, Rainbow Products have different alternative regarding the investment in new machinery and the continuous re-investment of the partial annual cash flows in the business in order to grow the annual cash flows.

Decision Criteria

Rainbow Products' management has designed a decision criteria on which it wants to evaluate the proposed invest in different alternative, which involves Payback Period, Net Present Value and Internal rate of return.

Analysis of Alternative

Alternative 1: Purchase of New Machine (base case scenario)

Under this alternative Rainbow Products will purchase a new machine in order to reduce its labor requirements,however, the outcomes of this alternative are as follows:

Net Present Value

Net Present value calculates the present value of future cash flows and cost saving if the investment in a particular project is done and uses the appropriate risk adjusted discount rate in order to arrive at the present value of investment. However, the evaluation of this alternative, at a discount rate of 12%, the present value of the project is negative, i.e. ($946), therefore on the basis of first decision criteria this project should not be proceeded under this alternative.

Internal Rate of Return

However, the internal rate of return calculates the maximum return that this investment project is expected to yield.Further, this alternate is expected to generate an internal rate of return not in excess of 11.49%, meanwhile, the risk, cost of capital for Rainbow Products is 12% for investment of fund into this project. Therefore, this project generates lower return on the investment in comparison to the cost of funds used; hence, this alternative also does not fulfill this decision criterion.

Payback Period

Additionally, payback period calculates the minimum period that a project will take to generate the net present value of the cash flows equal to its initial investment in this project. However, the evaluation of the alternative reveals that this project is not expected the receiver even its initial investment during the five year period, therefore, this alternative fails to meet the decision criterion.

Alternative 2: Additional Expenditure

This alternative considers the situation where an additional investment of $500 is made for the maintenance of the new machine in its original condition; however, the additional investment will be made from the annual cash flows generated by the project. The decision criteria are evaluated asunder:

Net Present Value

The decision to investment additional expenditure will increase the net present value of the proposed investment project to $36,554 which means that the this alternative will increase the net worth of Rainbow product equal to the net present value generated by this investment and positive net present value suggest that this alternative meets the decision criteria.

Internal Rate of Return

Further, the additional investment in this decision will increase the internal return to 27.20% from this project, which is higher than the cost of capital of Rainbow Products of 12%; hence, this alternative also meets the decision criteria of excess internal rate of return.

Payback Period

Additionally, the payback period of this investment will also be reduced to 5.16 years, which means that the additional investment will lead to the initial investment recovered in 5.16 years.

Alternative 3: Reinvestment of 20% Annual Cash Flows

Moreover, the third alternative is to reinvest the 20% of the annual cash flows generated by this project, which will increase the next year’s cash flows by 4%; however, the outcomes of this alternative are as follows;

Net Present Value

This alternative will also increase the net present value to $15,000 and will lead to value addition into Rainbow Product’s net worth by $15,000/-.

Internal Rate of Return

The internal rate of return from this alternate will be 17%, which is also higher than the cost of funds invested in this alternative; therefore, the decision criterion is satisfied.

Payback Period

Father the payback period under this alternative will become 14.15years, which means that under this alternative, the initial investment will be recovered in 14.15year period.........................

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