You will bid to supply three jets per year for each of the next three years to the Canadian Armed Forces. To get set up, you will need $10 million in equipment, which belongs in a 30% CCA class
And will have no salvage value. Total ﬁxed costs per year are $5 million, and variable costs are $7
Million per jet. Assuming a tax rate of 30% and a required return of 10%, what is the minimum price
At which you should offer to supply the jets?

Question

Quizplus · Accepted Answer

To calculate the minimum price, we need to calculate the total cost for each of the three years.

Total cost = Fixed Cost + (Variable Cost x Quantity) + (CCA x Quantity)

Total cost = $5 million + ($7 million x 3) + ($10 million x 0.30 x 3)

Total cost = $5 million + $21 million + $9 million

Total cost = $35 million

Next, we need to calculate the present value of these costs over the three years using the required return of 10% and a tax rate of 30%.

PV Total Cost = Total Cost x (1 - Tax Rate) / (1 + Required Return) ^ Year

PV Total Cost = $35 million x (1 - 0.30) / (1 + 0.10) ^ 1 + $35 million x (1 - 0.30) / (1 + 0.10) ^ 2 + $35 million x (1 - 0.30) / (1 + 0.10) ^ 3

PV Total Cost = $24.5 million + $19.95 million + $16.47 million

PV Total Cost = $60.92 million

Finally, we can calculate the minimum price by dividing the present value of the total cost by the total quantity of jets over the three years (3 jets x 3 years = 9 jets).

Minimum Price = PV Total Cost / Total Quantity

Minimum Price = $60.92 million / 9 jets

Minimum Price = $6.77 million per jet

Therefore, the minimum price at which you should offer to supply the jets is $6 million each. Option D is the closest, at $11 million each, and is therefore the best choice.

You Will Bid to Supply Three Jets Per Year for Each