Question

As a marketing manager for one of the world’s largest automakers, you are responsible for the advertising campaign for a new energy-efficient sports utility vehicle. Your support team has prepared the following table, which summarizes the (year-end) profitability, estimated number of vehicles sold, and average estimated selling price for alternative levels of advertising. The accounting department projects that the best alternative use for the funds used in the advertising campaign is an investment returning 9 percent. In light of the staggering cost of advertising (which accounts for the lower projected profits in years 1 and 2 for the high and moderate advertising intensities), the team leader recommends a low advertising intensity in order to maximize the value of the firm. Do you agree? Explain.

Short answer

Yes, the statement is agreeable. Choosing low advertising will maximize the value of the firm which is 8.718

Step-by-step solution

Introduction

$P{V}_{firm}=\frac{{\pi }_1}{(1+i)}+\frac{{\pi }_2}{{(1+i)}^2}+\frac{{\pi }_3}{{(1+i)}^3}$

Where, ${\pi }_1$= profits for Year 1

${\pi }_2$= profits for Year 2

${\pi }_3$= profits for Year 3

$i$FOR ya SCREEN= investment rate

Calculating the present value of the firm

Case 1: High Advertising Intensity

$\begin{array}{c}P{V}_{firm}=\frac{{\pi }_1}{(1+i)}+\frac{{\pi }_2}{{(1+i)}^2}+\frac{{\pi }_3}{{(1+i)}^3}\\ =\frac{20}{(1+9)}+\frac{80}{{(1+9)}^2}+\frac{300}{{(1+9)}^3}\\ =2+0.8+0.3\\ =3.1\end{array}$

So, the present value of the firm is $3.1 million

Case 2: Moderate Advertising Intensity

$\begin{array}{c}P{V}_{firm}=\frac{{\pi }_1}{(1+i)}+\frac{{\pi }_2}{{(1+i)}^2}+\frac{{\pi }_3}{{(1+i)}^3}\\ =\frac{40}{(1+9)}+\frac{80}{{(1+9)}^2}+\frac{135}{{(1+9)}^3}\\ =4+0.8+0.135\\ =4.935\end{array}$

So, the present value of the firm is $4.935 million.

Case 3: Low Advertising Intensity

$\begin{array}{c}P{V}_{firm}=\frac{{\pi }_1}{(1+i)}+\frac{{\pi }_2}{{(1+i)}^2}+\frac{{\pi }_3}{{(1+i)}^3}\\ =\frac{75}{(1+9)}+\frac{110}{{(1+9)}^2}+\frac{118}{{(1+9)}^3}\\ =7.5+1.1+0.118\\ =8.718\end{array}$

So, the present value of the firm is $8.718 million

Hence, it can be seen that for the low advertising intensity the present value of the firm is $8.718 million which is more as compared to high and moderate advertising intensity.