McDonnell Douglas Aircraft Corporation manufactures the C-17, the newest jet transport used by the U.S. Air Force. The company sells the C-17 for a “flyaway cost” of $175 million per jet. The variable production cost of each C-17 was estimated to be approximately $165 million. When the C-17 was first proposed, the Air Force expected to eventually purchase 400 jets. However, following the collapse of the former Soviet Union, the projected total purchase volume dropped to just 300 jets, then 200, then 150, and finally 120 jets.
Production began, and at one point the company was faced with the following situation.
With 20 jets finished, a block of 20 more in production, and funding approved for purchase of a third block of 20 jets, the U.S. Congress began indicating that it would approve funding for the order and purchase of only 20 more jets (for a total of 80). This was a problem for the company because company officials had indicated previously that the break-even point for the C-17 project was around 100 aircraft.
Because the company is headquartered in St. Louis, all the members of Congress from Missouri rushed to the company’s aid and now at least 120 C-17s will be ordered.
A. Assume that McDonnell Douglas must cover its fixed costs of $1 billion. Compute the actual break-even point for the C-17.
B. What would the income or loss be if the company only sold 80 C-17s?
C. Assume that McDonnell Douglas had been told up front that the Air Force would buy only 80 jets. Calculate the selling price per jet that the company would have to charge to achieve a target profit (before tax) of $10 million per jet.
D. Because McDonnell Douglas must provide its stockholders an acceptable return on their investment, how should the company manage the risks of projects such as the C-17 becoming a very big and expensive mistake?