Question

. Firm owned by investor (not involved in day to day management) who invested $500,000 $...

. Firm owned by investor (not involved in day to day management) who invested $500,000
$ Profit: $150,000/year
Best alternative: 12% in portfolio of stocks and bonds, i.e would have had 560,000 end of year. What is the economic profit?

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Homework Answers

Answer #1

Invested amount = $500,000

Profit earned = $150,000

The investors could have invested the amount in portfolio of stocks and bonds and would have earned $560,000.

So,

By investing in the firm, investors have foregone $60,000 to be earned through investment in stocks and bonds.

This is the implicit cost of investing in the firm.

Calculate the economic profit -

Economic profit = Profit earned from investing in the firm - Implicit cost of investing in the firm

Economic profit = $150,000 - $60,000

Economic profit = $90,000

Thus,

The economic profit is $90,000.

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