Instead of the service contract, Rainbow engineers have devised a different option to preserve and actually enhance the capability of the machine over time. At what sales volume did the Tri Star program reach true economic break-even?
Should Rainbow products purchase the machine with the service contract? From the above facts, it is quite evident that Tri Star should have not continued with the program at the end of the year In terms of the businesses strategy it might have been a reasonable decision, since it represents an order which might generate following orders, provided the project turns out to be successful for the customer.
Assume that all cash flows except the initial purchase occur at the end of the year, and do not consider taxes? Should Lockheed have continued the Tri star program at the end of ? We do not know that in this case. Therefore, Lockheed did not break even in value terms at a break-even production of units.
Solution: The Tri star program as evident from the data above was a disaster as the absolute returns are negative even after consideration of sales of units of commercial aircrafts. Instead, the contribution margin would be just 2 because below the production level of the production cost per unit is 14 million dollars.
What were the effects of these projects on Lockheed s shareholders? We use 2 million as contribution margin because we do not know what the production cost per plane is going to be because that depends on the final yearly output. Which rule should we use?We can verify this by comparing the net present values at the end of of both cash outflows and cash inflows. Should Rainbow purchase it? When the level of production is , each plane contributes 2 million to Lockheed. Solution: NPV Rule shall be chosen. We do not know that in this case. Instead, the contribution margin would be just 2 because below the production level of the production cost per unit is 14 million dollars. We do not treat them as sunk costs because they are so central in this project.
Solution: Herein, we consider year as base yr.