Honda Motor Company is considering offering a $ 1 comma 800 rebate on its minivan, lowering the vehicle's price from $ 29 comma 400 to $ 27 comma 600. The marketing group estimates that this rebate will increase sales over the next year from 39 comma 700 to 53 comma 200 vehicles. Suppose Honda's profit margin with the rebate is $ 5 comma 090 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? Hint: View this question in terms of incremental profits.

The cost of the rebate is that Honda will sell more vehicles and lose on each additional vehicle sold.

Explanation:

The cost-benefit analysis is a systematic approach that involves finding the marginal costs and marginal benefits associated with a particular decision, and then compare the benefits against the costs to determine whether the decision should be pursued.

To determine the costs and benefits in terms of incremental profits;

Benefit = Profit of $5,090 per vehicle × 13,500 (53200 - 39700) additional vehicles sold = $68,715,000  

The cost of the rebate is that Honda will make less on the vehicles it would have sold:

Cost = Loss of $1,800 per vehicle × 39,700 vehicles that would have sold without rebate = $71,460,000.

There, Benefit - Cost = $ (68,715,000 - 71,460,000) = - $2,745,000 and offering the rebate does not look attractive.

The rebate being offered is not a good idea as the cost outweighs the benefit.

B : $19,975.40

Explanation:  

The computation of the original investment is shown below:

Year          Cash flows             Discount rate at 12%          Present value

1                 $10,000                  0.8926                              $8,928.57

2                $8,500                    0.79719                            $6,776.15

3                $6,000                    0.71178                             $4,270.68

Total present value                                                           $19,975.40

In the case of IRR, the total of present value would be equivalent to the orginal investment