The Principle of No Arbitrage

1. What is the relation between the Law of One Price and the Principle of No Arbitrage?

2. How does the Valuation Principle help a financial manager make decisions?

3. Can we directly compare dollar amounts received at different points in time?

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?

 

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