Question

The accounting department at Frosty Cola has worked up the following figures for the year: (Show work for full credit)

                        Price per unit of Frosty Cola                          $1.75

                        Number of bottles of Frosty Cola sold           500,000

                        Utilities expense                                             $175,000

                        Telephone expense                                         $105,000

                        Accounting depreciation                                 $20,000

                        Wages paid to employees                               $100,000

                        Materials expense                                           $140,000

            a) The controller wants you to calculate the accounting profit to show the CFO.                                      

            b) However, you remember from your managerial economics course that managers sometimes like to see the economic profit of a business as well. Accordingly, you ask the accounting department for the following additional data:

                                    Total money invested in Frosty Cola over time         $1,000,000

                                    Economic depreciation                                               $45,000

                                    Current market interest rate                                        3 percent

                                    Owner’s normal profit estimate                                  $15,000

                        You decide to calculate economic profit and show this to the CFO as well.                                               

            c) The CFO is impressed that you wished to show her economic profit. She asks if the owner of the company made her normal profit last year. What would you tell her and why?

Answer 1

a) Accounting Profit = Total Revenue - Total Explicit Cost

   = (1.75 * 500000) - (175000+ 105000 +20000 +100000 +140000)

   = 875000 - 540000

   = $ 335000

b) Economic Profit = Accounting Profit - Total Implicit cost

   Now, opportunity cost is also implicit cost

   Now interest on 1000000 at 3% per annum would be earned if the money wasnt invested in business, which is an opportunity cost

   Therefore, interest = (1000000 *3) /100 = 30000

   therefore, economic profit = 335000 - 30000 - 45000 - 15000

= $ 245000

C) The company made her more than the normal profit last year as the Total revenue is greater than total costs.