Question

Howard Bowen is a large-scale cotton farmer. The land and machinery he owns has a current market value of $11 million. Bowen owes his local bank $9 million. Last year Bowen sold $10 million worth of cotton. His variable operating costs were $8 million; accounting depreciation was $40,000, although the actual decline in value of Bowen's machinery was $60,000 last year. Bowen paid himself a salary of $50,000, which is not considered part of his variable operating costs. Interest on his bank loan was $400,000. If Bowen worked for another farmer or a local manufacturer, his annual income would be about $30,000. Bowen can invest any funds that would be derived if the farm were sold to earn 10% annually. (Ignore taxes.)

What is Bowen's accounting profit?

$1,560,000

$1,550,000

$1,310,000.00

$1,320,000.00

What is Bowen's economic profit?

$1,560,000

$1,310,000.00

$1,550,000

$1,320,000.00

Answer 1

Solution:-

a) Bowen’s accounting Profit:-

Revenue = $11,000,000

Less: Variable operating costs =$9,000,000

Less: Depreciation =$40,000

Equals : Operating Income = $1,960,000

Less: Interest Expense =$400,000

Accounting income before tax = $1,560,000

Correct option is (A)

Bowen’s accounting Profit is $1,560,000

b) Bowen’s Economic Profit:-

Revenues =$11,000,000

Less: Variable operating costs =$9 000,000

Less: Opportunity value of Bowen's income potential =$30,000

Less: Economic depreciation =$60,000

Equals: Economic profit before financial costs =$1,910,000

Less: Interest expense =$400,000

Less: Opportunity cost of =$2 million

equity investment =$200,000

Equals: Economic profit= $1,310,000

Correct option is (B)

Bowen’s Economic Profit is $1,310,000