Question

# John was a high school teacher earning \$ 80,000 per year. He quit his job to...

John was a high school teacher earning \$ 80,000 per year. He quit his job to start his own business in pizza catering. In order to learn how to run the pizza catering business, John enrolled in a TAFE to acquire catering skills. John’s course was for 3 months. John had to pay \$2,000 as tuition for the 3 months.

After the training, John withdrew \$110,000 from his savings account. He had been earning 5 percent interest per year for this account. He also borrowed \$50,000.00 from his friend whom he pays 6 percent interest per year. Further, to start the business John used his own premises. He was receiving \$12,000 from rent per year. Finally, to start the business John uses \$50,000 he had been given by his father to go on holiday to USA.

John’s first year of business can be summarised as follows:

 Item Amount \$ Revenue- Pizza Section 400,000 Revenue- Beverages Section 190,000 2 Cashiers (wages per worker) 55,000 Pizza ingredients 50,000 Manager 75,000 3 Pizza bakers (wages per baker) 60,000 Equipment 10,000

Based on your calculated accounting profit and economic profit, would you advise John to return to his teaching job?  Show your work

#### Homework Answers

Answer #1

Accounting profit (\$) = Total revenue - Total Wages - Ingredients - Manager salary - Equipment - Interest payment

= (400,000 + 190,000) - [(2 x 55,000) + (3 x 60,000)] - 50,000 - 75,000 - 10,000 - (50,000 x 6%)

= 590,000 - (110,000 + 180,000) - 135,000 - 3,000

= 162,000

Economic profit (\$) = Accounting profit - Implicit costs

= Accounting profit - Salary given up - Interest income on savings given up - Rental income given up

= 162,000 - 80,000 - (110,000 x 5%) - 12,000

= 70,000 - 5,500

= 64,500

Since Economic profit > 0, he should open the business.

NOTE: The TAFE course fee is a sunk cost, which couldn't be recovered even if he didn't start pizza business. Sunk cost is excluded from economic costs.

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