Question

You will bid to supply 5 Navy Destroyers per year for each of the next three years to the U.S. Navy. To get set up you will need $90 million in equipment, to be depreciated straight-line to zero over the next three years, with no salvage value. Total fixed costs per year are $10 million, and variable costs are $15 million per Destroyer. Assume a tax rate of 35 percent and a required return of 12 percent. What is the minimum price per destroyers you should bid to the U.S. Department of Defense? (You may round your answer to the nearest dollar.)

Answer 1

We bid to supply 5 distroye to us navy par year for next 3 year

For this we need equipment of 90 million $

With zero salvage value depreciation over three years

Yearly depreciation = 90/3

= 30 million dollars

Tax saving in depreciation =30*.35

=10.5 millon per year for 3

Annual fixed cost =10 million dollars

Veriable cost =15 million per distroyer or say 15*5 = 75 million per year

Total cost (veriable + fix) (10+75) = 85 million
Net cost per year = total cost - tax benefit on depreciation
=85-10.5
=74.5 million dollars
Required rate of return = 12%

Let us suppose price per distroyer be x than

	1	2	3
Revenue	5x	5x	5x
Less- net cost	74.5	74.5	74.5
Net	5x-74.5	5x-74.5	5x-74.5

Present value @12% for

Year 1)( 5x-74.5)/1.12 =4.46x-66.5178571

Year2)(5x-74.5)/(1.12)^2=3.985x-59.39094

Year3)(5x-74.5)/(1.12)^3=3.56x-53.027628

Total.     = 12.009156341x-178.936429482

To find price of distroyer

Initial outflow =present value of all cash folw

90= 12x-178.936429482

X=88.936429482/12.009156341

=7.405718 million $ or 7405718 $

So we should bid 7405718 $ per distroyer