Question

Answer if you are 100% sure.

You read a story about a company, ACME Corporation, that earned $100 million last year and is forecasting a profit of $150 million this year. Because you are not quite sure about this opportunity, you ask your friend for more information on ACME. Your friend enthusiastically tells you that ACME is a very large company with assets of $10 billion.

How much economic profit (rate of return) is this company forecasting in the upcoming year?

Answer 1

The accounting profit does not mean that ACME earns an economic profit. First, consider the difference between the accounting profit and the economic profit.

Economic profit is total revenue minus explicit and implicit (opportunity) costs. In contrast, accounting profit is the difference between total revenue and explicit costs. It does not take opportunity costs into consideration, and is generally higher than economic profit.

We know that the company earned an accounting profit of $100 million on assets of $10 billion.

Calculate the return:

$100 million / $10 billion = 1 percent

( 1 billion = 1000 million)

Next year's forecast of $150 million profit represents a 1.5 percent return

= 150 million / 10 billion = 0.015 = 1.5%

1.5 percent is a pretty low return. The firm could earn more with alternative investment.