An owner can lease her building for $100,000 per year for three years. The expli

Question

An owner can lease her building for $100,000 per year for three years. The explicit cost of maintaining the building is $35,000, and the implicit cost is $50,000. All revenues are received, and costs are borne, at the end of each year. If the interest rate is 4 percent, calculate the present value of the stream of flow. (Hint: you need to calculate the revenue and cost at the end of each three years and discounted all those streams back to the present value at present interest rate))

a. Accounting profits

b. Economic profits

Explanation / Answer

Accounting Profit:
First you need to start with the Account Profit formula:

Accounting Profit = Total Revenue - Explicit Cost
Accounting Profit = $100,000-$35,000
Accounting Profit = 65,000

After you find your Accounting Profit you need to use the Present Value of a Stream Formula which is:

PV = FV1/(1+i)^1 + FV2/(1+i)^2 + FV3/(1+i)^3

After plug in what you know..

PV = 65000/(1+4%)^1 + 65,000/(1+4%)^2 + 65,000/(1+4%)^3
PV = 217,859.84

So the owners Accounting Profit is 217,859.84


Economic Profit:
For Economic Profit you need to start with the Economic Profit formula:

Economic Profit = Total Revenue - (Explicit Cost+Implicit Costs)
Economic Profit = $100,000 - (40,000+55,000)
Economic Profit = 5,000

After you have found the Economic Profit you need to use the Present Value of a Stream Formula, which is:

PV = FV1/(1+i)^1 + FV2/(1+i)^2 + FV3/(1+i)^3

After plug in what you know..

PV = 25,000/(1+5%)^1 + 25,000/(1+5%)^2 + 25,000/(1+5%)^3
PV = 68,081.20

So the owners Economic Profit is 68,081.20

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