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MAKING
LOCKHEED TRI STAR CASE STUDY
BY- ARWA KHERIWALA
Introduction
Highly regarded by the military, Lockheed sought to move into the
lucrative civilian commercial aviation sector and compete with Boeing,
McDonnell Douglas and Airbus. Lockheed began design and testing in 1966
on their entry, the Tri Star, which boasted a range of over 6,000 miles
with nearly 400 passengers and speeds of close to 600 mph. They had
already invested nearly $900 million in development costs. Carried by state
of the art Rolls Royce turbofan engines, the L-1011 was by all accounts, a
technological winner and might be the companys ticket back to solvency.
Problem
The summer of 1971 found the once formidable company on the brink of
disaster. Despite the nearly $1 billion in sunk costs, Lockheed was in
need of $250 million more to bring the plane to market, but its bankers
would not commit without federal loan guarantees. Spokespersons for
Lockheed claimed before Congress that the Tri-Star program was
economically sound and that their problem was mere liquidity crisis.
However, opposition to the guarantee focused on estimated break-even
sales the number of jets that would need to be sold for total revenue to
cover all accumulated costs.
The decision to invest in the Tri-Star project by forecasting the cash flow
associated with the project for a volume of 210 planes.
A valid estimate of the NPV of the Tri-Star project at a volume of 210
planes as of 1967 was -$584 M. This was clearly an unacceptable NPV.
Analysis and Solution
Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10
Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977
Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10
Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977
Investment (100) (200) (200) (200) (200)
Cost 0 0 0 0 (625) (625) (625) (625) (625) (625)
Revenue 600 600 600 600 600 600
Pre-Revenue 200 200 200 200 200 200
Cash Flow (100) (200) (200) 0 (625) 175 175 175 175 (25) 600
At what sales volume did the Tri-Star program reach the true economic ( as
opposed to accounting ) break-even?
-Tri-Star reached the true economic ( as opposed to accounting ) break-even at 400
Units.
Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10
Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977
Investment (100) (200) (200) (200) (200)
Cost 0 0 0 0 (767) (767) (767) (767) (767) (767)
Revenue 840 840 840 840 840 840
Pre-Revenue 280 280 280 280 280 280
Cash Flow (100) (200) (200) 80 (687) 353 353 353 353 73 840
The decision to pursue the Tri Star program was unreasonable and
overly ambitious. If the proper analysis was completed, this project
may have been terminated and the company could have invested its
capital in a profitable investment that would have increased
shareholder wealth.
Lockheed TriStar Case Study- Appendix IV
Production @ 500 Units
Lockheed Tri Star
Time Index t=0 t=1 t=2 t=3 t=4 t=5 t=6 t=7 t=8 t=9 t=10
Years 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977
Cash Flow (100) (200) (200) 133 (783) 417 417 417 417 83 1000
Despite industry analysts prediction that 300 units as Lockheeds break-even sales point, at this
level, net present value remained insufficient to cover costs at negative $ 329.26 million. At 275
planes costing $3.5 million each, the company achieved accounting breakeven at $962.5 million
profit vs. $960 million in development costs. If the company had performed a true value break-
even analysis, management would have realized that roughly 400 Tri Star aircraft (about 67 per
year for six years) costing somewhere between $11.5 million and $12 million per unit would have
to be sold in order to break even.
The decision to pursue the Tri Star program was unreasonable and overly ambitious. If the proper
analysis was completed, this project may have been terminated and the company could have
invested its capital in a profitable investment that would have increased shareholder wealth.
Instead, the decision resulted in Lockheeds share price plummeting from $64 (Jan 1967) to $3.24
(Jan 1974).
The Lockheed Tri Star was an unfortunate case of a loss so big, it made history. Their initial
estimates to break-even proved to be extremely optimistic. Based on the cost data presented, it
is apparent the shareholders were poorly served, as investors evidently more properly valued the
project in the free market.
Given flawed decision-making, Lockheed lost $2.5 billion on the TriStar project and the
experience buried them in commercial aerospace.
Recommendation
Solution Reasons for having Product-Mix