1. Problem #1 1

2. 2

3. 3

4. 4

5. 5 Investment Criteria Summary Ranking by Investment Criterion

6. What explains the differences in the rankings? – Payback method Reflects the relative timing of cash flows but is insensitive to the total amount of cash flow beyond the payback horizon Ignores the time value of money and the riskiness of the cash flows If a company is operating under binding capital constraints, the payback period is a crude indicator of how quickly funds are recovered to fund other projects in the queue 6

7. – Accounting ROI Provides some indication of how a project will affect some traditional measures of performance Does not reflect true cash flow, time value of money, and risk –NPV –Reflects time value of money and risk –Gives us a $ measure of the value of a project –IRR will give a similar decision as NPV (i.e., “accept” or “reject”, as long as cash flows are conventional 7

8. What project should be accepted? – If projects are independent, should accept according to NPV ranking until capital runs out – If projects are mutually exclusive, should accept either C or D, depending on the hurdle rate The differences in the NPV rankings reflect the relative timing of the cash flows. Such timing differences are not captured by the IRR (e.g. the IRR assumes for project D that the $10 million inflow in year 1 is reinvested at a rate equal to the IRR) 8

9. Problem #2 9

10. 10 Yes, the project should be undertaken because it has a positive NPV of $905, 861. $1 million of development costs are sunk costs and should not be included in the analysis

11. Management discloses it will issue new shares to finance a new project – Project NPV = $100,000 – The market knows this and it is immediately reflected on the stock price. That is, the stock price will rise to $110 – Thus, only 1,000 new shares need to be issued to fund the $110,ooo cost of the new project. – The market value of VAI will rise to $1,210,000 – Current shareholders will gain the full value of the project (i.e. 10%), new shareholders will pay full (but fair) price for ownership in the firm 11 Problem #3

12. Problem #4 12 At 210 units

13. 13 At 300 units

14. 14 Economic break-even at approximately 480 units

15. At originally planned production levels, the project would have destroyed value for the firm Economic break-even is closer to 480 units (compared with total world market of 323 – 775 planes) 15

16. Lockheed Martin’s stock price