Question

Here is the problem that I am trying to resolve from Corporate Finance (5th edition) by Berk & DeMarzo:

1. Honda Motor Company is considering offering a $2000 rebate on its minivan, lowering the vehicle’s price from $30,000 to $28,000. The marketing group estimates that this rebate will increase sales over the next year from 40,000 to 55,000 vehicles. Suppose Honda’s profit margin with the rebate is $6000 per vehicle. If the change in sales is the only consequence of this decision, what are costs and benefits? Is it a good idea?

I used the NPV = PV (Benefits) - PV (Costs) formula to come up with costs and benefits. I found that costs would amount to $879,680,000 and benefits would amount to $320,000,000 without lowering the vehicle's price. Costs would amount to $1,210,000,000 and benefits would total $310,000,000 with lowering the vehicle's price. The difference in NPV would amount to $10,000,000 making lowering the vehicle's price a good idea.

As I am new to financial accounting, I am wondering if the answer that I came up with is correct?

Answer 1

You are correct!!! another method is as follows

Without giving rebate the costs are

intial cost= Profit margin + rebate= 6000+2000=8000

Costs= no of vehicles initially * costs= 40000*8000= 320000000

costs= 320000000

After giving rebate of 2000 Profit margin is 6000 and sales increased by 15000

so Benefits= profit margin* vehicles sold= 6000*55000

Benefits = 330000000

Hence, Beneift- costs = 330000000- 320000000 = 10000000

NPV= 10000000

Look there, we got a profit of 10 million USD. Hence it is a good idea to give rebate.

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