9. Suppose the CFO gives you the following data from last year’s operations:
Number of units sold 10,000
Price per unit $5
Market interest rate 2 percent
Owner’s forgone salary at Firm X $50,000
Accounting depreciation $ 8,000
Economic depreciation $ 5,500
Owner’s forgone salary at Firm M $42,000
Owner’s own money invested in firm $100,000
Normal profit $ 1,000
Utilities expense $ 12,000
Rent expense $ 15,000
Materials expense $ 5,000
Wages paid $ 30,000
a) What was the accounting profit for the owner’s firm for the year?
b) What was the economic profit for the owner’s firm for the year?
c) Did the owner make his normal profit last year? How do you know?
Ans:
a) Accounting profit = -$20,000
b) Economic profit = -$77,500
c) No, owner did not make his normal profit last year as the economic profit is negative.
Explanation
Revenue = price * quantity
= $5 * 10,000
= $50,000
Explicit cost = material expenses + wages + rent + utilities + accounting depreciation
= $5,000 + $30,000 + $15,000 + $12,000 + $8,000
= $70,000
Implicit cost = salary forgone + interest forgone + economic depreciation
= $50,000 + ($100,000 * 2%) + $5,500
= $50,000 + $2000 + $5,500
= 57,500
Accounting profit = Revenue - Explicit cost
= $50,000 - $70,000
= -$20,000
Economic profit = Revenue - Explicit cost - Implicit cost
= $50,000 - $70,000 - $57,500
= -$77,500
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