Question

You are currently a worker earning $60,000 per year but are considering becoming an entrepreneur. You will not switch unless you earn an accounting profit that is on average at least as great as your current salary. You look into opening a small grocery store. Suppose that the store has annual costs of $150,000 for labor, $60,000 for rent, and $30,000 for equipment. There is a one-half probability that revenues will be $200,000 and a one-half probability that revenues will be $420,000.

a. In the low-revenue situation, what will your accounting profit or loss be?

In the high-revenue situation, what will your accounting profit or loss be?

b. On average, how much do you expect your revenue to be?

Your accounting profit?

Your economic profit?

Will you quit your job and try your hand at being an entrepreneur?

   (Click to select)  No  Yes

c. Suppose the government imposes a 25 percent tax on accounting profits. This tax is only levied if a firm is earning positive accounting profits. What will your after-tax accounting profit be in the low-revenue case?

In the high-revenue case?

What will your average after-tax accounting profit be?

Your accounting profit?

Your economic profit?

Will you quit your job and try your hand at being an entrepreneur?

   (Click to select)  No  Yes

c. Suppose the government imposes a 25 percent tax on accounting profits. This tax is only levied if a firm is earning positive accounting profits. What will your after-tax accounting profit be in the low-revenue case?

In the high-revenue case?

What will your average after-tax accounting profit be?

Answer 1

Solution:-

Total cost = 150,000 + 60,000 + 30,000 = 240,000

(A).acc profit = 200,000 - 240000 = -40000

Therefore, accounting loss of 40,000 (low rev)

Acc profit = 420,000 - 240000 = 180000

Therefore, accounting profit of 180000 (high rev)

(B).Expected revenue = 0.5(200000) + 0.5(420000) = 310000

Accounting profit = 0.5(-40000) + 0.5(180000) = 70000

Economic profit = 70000 - 60000 = 20000

Yes, quitting my job will give me an economic profit of 10000.

(C).At the low revenue case, no tax will be levied; hence, accounting loss is still -40,000.

At the high revenue case, acc profit = 0.75(180000) = 135000

Accounting profit = 0.5(-40000) + 0.5(135000) = 47500

Economic profit = 47500 - 60000 = -12500

Nope, I would rather continue my job.