Question

Q5: Bolin is thinking about quitting his current job, which pays a salary of $56,000 per year, to own and operate his own business. Investors are able to earn 14% from businesses that are equally risky as Bolin's intended business. If he started the business, he would spend $250,000 to purchase physical capital. This amount of money would come from two sources: $120,000 would be borrowed from a bank at an interest rate of 8% per year and $130,000 would come from Bolin's savings that are currently earning 0.8% in a risk-free savings account. The physical capital is expected to have useful life of 10 years and a scrap value of $23,000. Bolin expects to spend $150,000 per year on assistants and will pay himself a salary of $24,000 per year while operating his business. His business is expected to earn total revenues of $280,000. After learning that Bolin might quit, his employer offers him a salary of S65,000 per year to convince him to stay at his current job.

Answer 1

Revenue = $280,000

(a) Explicit costs= depreciation of fixed assets+ Interest paid on loan + Interest on savings account + salary of employees+ Rick's salary

Explicit costs= [(250,000-23,000)/10] + [ 120,000 * 8% ] + [130,000 * 0.8% ] + 150,000 + 24,000

Explicit costs= 22,700+9,600+1,040+150,000+24,000

Explicit costs= $207,340

Accounting profit= Revenue - Explicit costs

Accounting profit= 280,000 - 207,340

Accounting profit= $72,660

(b) Implicit costs= Salary of previous job= $65,000

Economic costs= Explicit costs+Implicit costs

Economic costs= 207,340+65,000

Economic costs= $272,340

Economic profit= Revenues - Economic costs

Economic profit= 280,000 - 272,340

Economic profit= $7,660