Suppose you are considering starting your own consulting firm. You estimate if t
ID: 1203450 • Letter: S
Question
Suppose you are considering starting your own consulting firm. You estimate if that if you did not start the firm, your starting salary at a job would be $40,000/yr. The revenues from this firm are expected to be $1,500,000. Some of the expenses you expect to encounter is $25,000 for an employee and operating costs (rent, supplies, utilities, etc.) of $500,000. To begin the business, you must borrow $100,000 from the bank and pays 8% interest in the loan and also uses $50,000 of your own money that was in a savings account previously earning 2% interest. Equipment (computers, etc.) will cost $20,000.
a. Determine the pre-tax accounting profit of this firm
b. Determine the pre-tax economic profit of this firm
c. Which costs are explicit and which costs are implicit?
Explanation / Answer
a.
Pre-tax accounting profit:
Revenues
$1,500,000
Less: Expenses
Employee salary
$25,000
Operating cost
$500,000
Interest on loan (100,000 × 8%)
$8,000
Accounting profit
$967,000
b.
Pre-tax economic profit:
Revenues
$1,500,000
Less: Expenses
Employee salary
$25,000
Operating cost
$500,000
Interest on loan (100,000 × 8%)
$8,000
Accounting profit
$967,000
Less: Opportunity costs:
Salary per year
$40,000
Interest on savings (50,000 × 2%)
$1,000
Economic profit
$926,000
c.
Explicit costs: Employee salary, Operating cost, and Interest on loan
Implicit costs: Salary per year, Interest on savings
Revenues
$1,500,000
Less: Expenses
Employee salary
$25,000
Operating cost
$500,000
Interest on loan (100,000 × 8%)
$8,000
Accounting profit
$967,000
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