Please show all work so i can learn the steps in how it was resolved. You own a
ID: 1174328 • Letter: P
Question
Please show all work so i can learn the steps in how it was resolved.
You own a Down Under Sandwich Shoppe that has gross sales averaging $420,000 a year. You pay $40,000 a year in interest on a business bank loan. You also invested $70,000 of your own money in the business (on which you were earning 6% per annum interest). NOTE: neither the bank loan principle, nor the $70,000 of your own money is an explicit or an implicit expense. However, the interest paid on the loan is explicit and the interest foregone on your savings is implicit. You have to pay Down Under Inc. a franchise fee of $3,000 a year plus 2% of your gross sales. Your shop is located in a building you own (but you formerly leased it for $21,600 so you no longer receive this rent and thus its lost is an implicit cost). The labor you hire costs you $160,000 a year. Utilities cost $4,000 a year. Food ingredients (pizza dough, meat, cheese, sauce, soft drinks, etc) cost $130,000 a year. You spend 2% of your gross sales on advertising. Income taxes last year were 3.5% of gross sales, and are an explicit annul business expense. You quit a good job as the manager of Ramani’s Pizzeria that paid you $30,000 a year to go into business for yourself, so this is an implicit cost.
What is the estimated explicit (accounting) cost of this business? Itemize in detail.
What is the accounting profit from the business?
What is the total implicit cost of this business? Itemize in detail.
How much economic profit, if any, is being made?
You pay 10% per annum interest for your bank loan. How much did you borrow?
From the economic viewpoint, should you stay in this business? Explain.
Explanation / Answer
(1) Loan from bank = Annual interest / Interest rate = $40,000 / 0.1 = $400,000
(2)
Accounting costs ($) = Loan interest + Franchise fee + Labor cost + Utilities + Food ingredients + Advertising + Income tax
= 40,000 + [3,000 + 2% x 420,000] + 160,000 + 4,000 + 130,000 + (420,000 x 2%) + (420,000 x 3.5%)
= 40,000 + 3,000 + 8,400 + 160,000 + 4,000 + 130,000 + 8,400 + 14,700
= 368,500
Implicit cost ($) = Interest foregone + Rent foregone
= 70,000 x 6% + 21,600 = 4,200 + 21,600
= 25,800
Economic profit = Revenue - Accounting cost - Implicit cost
= $(420,000 - 368,500 - 25,800)
= $25,700
Since economic profit is positive, I would stay in business.
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