(a)
To calculate:
The accounting profits.
Answer to Problem 10CACQ
The total accounting profit is $240,000.
Explanation of Solution
The accounting profits at the end of each of three years for the owner of the building as follows:
Given,
The annual rent earned by leasing the building is $120,000, and
The annual explicit cost of maintaining the building is $40,000.
Calculate the accounting value as follows:
Thus, annual accounting profits for the building owner is $80,000.
Since the building owner is considering leasing it for three years and the rent and the costs are identical at the end of each year, her accounting profits will also be identical at the end of each year.
Calculate the total accounting profit as follows:
Thus, the total accounting profit is $240,000.
Present value of the stream of accounting profits:
Use the following equations to find the present value of the accounting profits:
Where,
PV is the present value of the accounting profit from the building.
FV1 is the accounting profits at the end of the first year.
FV2 is the accounting profit at the end of second year, and
FV3 is the accounting profits at the end of third year.
In this case,
FV1is $80,000,
FV2is $80,000 and
FV3is $80,000.
Calculate the present worth as follows:
Thus, although the building owner will earn a total accounting profit of $240,000 in the next three years, the present value of these accounting profits is $217,859.84 only.
Explicit cost:
Explicit cost is the cost incurred by a firm and is paid exclusively and recorded in books of accounts. For example, wages paid to workers.
Implicit cost:
Implicit cost is the cost incurred by a firm which is imputed and is not recorded in books of accounts. For example, the rent, salaries which owner foregoes as he employs his own resources.
(b)
To calculate:
The economic profits.
Answer to Problem 10CACQ
The economic profit is $75,000.
Explanation of Solution
The economic profits at the end of each of three years for the owner of the building as follows:
Given,
The annual rent earned by leasing the building is $120,000.
The annual explicit cost of maintaining the building is $40,000.
The annual implicit cost of maintaining the building is $55,000.
The annual rent earned by leasing the building is $120,000.
The annual explicit cost of maintain the building is $40,000 and
The annual cost of maintain the building is $55,000.
Economic profit is as follows:
Since the building owner is considering leasing it for 3 years and the rent and costs are identical at the end of each year, her economic profit will be identical at the end of each year.
Thus, the economic profit is $75,000.
Present Value of the stream of economic profits:
Present Value of the economic profits from the building over three years is as follows:
Here,
PV is the present value of the accounting profit from the building,
FV1 is the accounting profits at the end of the first year,
FV2 is the accounting profit at the end of second year, and
FV3 is the accounting profits at the end of third year.
In this case,
FV1is $25,000
FV2is $25,000
FV3is $25,000.
Calculate the present worth as follows:
Thus, although the building owner will earn a total economic profit of $75,000 in the next three years, the present value of these economic profits is $68,081 only.
Economic profit:
The opportunity costs and explicit costs when deducted from the earned revenues gives economic profit. The economic profit is that profit which is earned after exceeding the opportunity costs.
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Chapter 1 Solutions
Managerial Economics & Business Strategy (Mcgraw-hill Series Economics)
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