Funding a Missile Program Merowak Missiles is proposing to develop its next generation Democratizer Offensive Weapon System II (DOWS II) for the US military. It expects to have to sink $1 billion into R&D and design, spend $0.5 billion building the

tools and production facility that are unique to DOWS II production. It houses these in standard factory floor space that costs $1 million. Each missile has a marginal cost of $2,000 . The Pentagon is considering ordering 1 million of these missiles. What is the average cost per missile that Merowak could bid for the contract?

Fixed costs are the $1 billion R&D and design costs, $0.5 billion for specialized tools and facility are not yet sunk and, therefore, relevant to the decision. The $100,000 for the factory floor space can be avoided because it can be repurposed for any manufacturing. So the average avoidable costs are $2,000 + $1.501 billion / 1 million = $17,001 per missile.