Question

4. Suppose that you have 1 million euros set aside for investment and suppose that there are only 3 investment opportunities available: 1) invest in Project A, which offers 6% return; 2) invest in Project B, which offers 10% return, or 3) invest in project C, which offers 15% return.

a) What is your economic profit if you invest in project A?

b) What is your economic profit if you invest in project C?

Answer 1

Accounting profit from Project A = 6% * 1,000,000 = 60,000 euros

Accounting profit from Project B = 10% * 1,000,000 = 100,000 euros

Accounting profit from Project C = 15% * 1,000,000 = 150,000 euros

Economic profit = Profit from an investment - Profit from best alternative.

a) Economic profit by investing in Project A = 60,000 - 150,000 = -90,000

That is it incurs an economic loss of 90,000 euros.

b) Economic profit of investing in Project C = 150,000 - 100,000 = 50,000 Euros

That is the profit equals 50,000 euros