2. You have worked as a real estate agent for 10 years and are earning about $10

Question

2. You have worked as a real estate agent for 10 years and are earning about $100,000 per year with your current agency. You prepared the following information to use in evaluating the financial feasibility of starting your own agency: Revenues generated during the first year of operations: $1.5 million Salaries and other labor costs paid to employees during the first year of operations: $1 million Operating expenses (e.g., rent, communications: $150,000 Equipment purchases: $100,000 with a 5 year straight line depreciation You need $100,000 in equity, which you can withdraw from your bank account that is currently paying 2% per year in interest, and a $400,000 loan with a 15% interest rate. a. What is your expected pretax accounting profit from your proposed agency? b. What is your expected pretax economic profit from your proposed agency? c. Identify the explicit versus implicit costs.

Explanation / Answer

a.Accounting Profit = Revenue - Operating Cost - Depreciation -Interest Interest = $400,000 *15% Depreciation =$100,000/5 Accounting Profit =$1.5 million -$1.0 million -$150,000 -$100,000/5 -$400,000 *15% =$270,000 b. Economic Profit = Accounting Profit-Opportunity Cost Opportunity Cost = forgone interest on equity =$100,000*2% = 2000 Economic Profit =$270,000-2000 =268000 c.Explicit costs: Salaries and other labor costs paid to employees Operating expenses (e.g., rent, communications) Interest Implicit Costs Forgone interest on $100,000 equity Depreciation

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