Question

Jamie is considering leaving her current job, which pays $75,000 per year, to start a new company that develops applications for smartphones. Based on market research, she can sell about 50,000 units during the first year at a price of $4 per unit. With annual overhead costs and operating expenses amounting to $145,000, Jamie expects a profit margin of 20 percent. This margin is 5 percent larger than that of her largest competitor, Apps, Inc.

a. If Jamie decides to embark on her new venture, what will her accounting costs be during the first year of operation? Her implicit costs? Her opportunity costs?

Accounting costs: $ _________________
Implicit costs:        $ ________________
Opportunity costs: $ _____________________

b. Suppose that Jamie’s estimated selling price is lower than originally projected during the first year. How much revenue would she need in order to earn positive accounting profits? Positive economic profits?

Revenue needed to earn positive accounting profits: $ __________________
Revenue needed to earn positive economic profits:   $ ___________________

Answer 1

a) The value of salary foregone is $75,000. This represents the implicit cost which is not incurred explicitly but is realized in terms of lost opportunity. Explicit costs are $145,000. Hence, accounting cost is $145,000, implicit cost is $75,000 and total opportunity cost (sum of explicit and implicit cost) is $220,000.

b) Note that revenue should be $200,000 based on the sales of 50,000 units at a price of $4 per unit. But if this is not the case, then the revenue required to be earned to have at least some accounting profit should be greater than or equal to $145,000. Similarly, the revenue required to be earned to have at least some economic profit should be greater than or equal to $220,000