3 . John Jones owns and manages a cafe in Collegetown. His monthly revenue is $5

Question

3. John Jones owns and manages a cafe in Collegetown. His monthly revenue is $5000. Monthly expenses are shows in the following list:

a. Calculate John's monthly accounting profit.

b. John could earn $1000/month as a recycler of aluminum cans. However, he prefers to run the cafe. In fact, he would be willing to pay up to $275/month to run the cafe than to recycle. Is the cafe making an economic profit? Will John stay in the cafe business? Explain.

c. Suppose the cafe's revenues and expenses remain the same, but recycler's earnings rise to $1100/month. Is the cafe still making an economic profit? Explain.

d. Suppose that intead of borrowing $10,000 at a monthly interest rate of 10% to buy equipment, John had invested $10,000 of his own money in equipment. How would you answers to part (a) and (b) change?

e. If John can earn $1000/month as a recycler and he likes recycling just as well as running the cafe, how much additional revenue would the cafe have to collect each month to earn a normal profit?

Labour $2000 Food & Drink $500 Electricity $100 Vehicle Lease $150 Rent $500 Interest on loan for equipment $1000

Explanation / Answer

(a)

Accounting profit = Revenue - all monthly expenses

= $5,000 - $(2,000 + 500 + 100 + 150 + 500 + 1,000) = $5,000 - $4,250

= $750

(b)

Additional implicit cost = $1,000 + $275 = $1,275

Subtracting this implicit cost from accounting profit gives us an Economic loss of $(1,275 - 750) = $525.

If John goes by accounting profit only, he will stay in cafe business, but going by economic profit, he will not (since there is an economic loss).

(c)

Since there was already an economic loss in part (b), increase in recycler salary will add to the economic loss and the amount of economic loss will increase by $100 to $625.

(d)

Personal investment of $10,000 will result in an interest saving of $1,000.

So, accounting profit will increase by $1,000 to $1,750.

Economic profit = $1,750 - $1,275 = $475

This will be a confirmation of John staying in the cafe business, inspired by both accounting and economic profit.

(e)

This option will reduce $275 of economic (implicit) cost. Revised implicit cost = $1,000.

Revised economic profit = Accounting profit - $1,000 = $750 - $1,000 = - $250 (Loss)

So, revenue has to increase by $250 to cover this loss and make a normal profit.

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.