Chapter 3, Problem 1P

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 its costs and benefits? Is it a good idea?

Summary Introduction

To determine: The cost and benefits.

Introduction:

While evaluating the firm’s decision, the benefits and incremental costs must be valued, as it is associated with the decisions. When the benefits exceed the cost, then it will be termed to be a good decision.

Answer to Problem 1P

The cost and benefits are $90 million and $80 million.

Explanation of Solution

Given information:

HM Company offers $2,000 rebate on its vehicle minivan. The price of the vehicle drops from $30,000 to $28,000. The sales could increase from $40,000 to $55,000 over the next year. The profit margin is $6,000 per vehicle.  

The formula to calculate the benefits and cost of the firm:

$\text{Benefits}=\text{Profit per vehicle}\times \text{Additional vehicles sold}$

$\text{Costs}=\text{Loss per vehicle}\times \text{Vehicles sold without rebate}$

Compute the benefits and cost of the firm:

$\begin{array}{c}\text{Benefits}=\text{Profit per vehicle}\times \text{Additional vehicles sold}\\ =\text{\$6,000}\times \left(55,000-40,000\right)\\ =\$60,000\times 15,000\\ =\$90\text{million}\end{array}$

Hence, the benefits are $90 million.

$\begin{array}{c}\text{Costs}=\text{Loss per vehicle}\times \text{Vehicles sold without rebate}\\ =\text{\$2,000}\times 40,000\\ =\$80\text{million}\end{array}$

Hence, the costs are $80 million.

Summary Introduction

To discuss: Whether the idea is a good one.

Explanation of Solution

The benefits over costs are $\$90\text{million}-\text{\$80 million}=\$10\text{million}$ that is the benefits are more than the costs. This shows that the offering of a rebate is a good idea.