Question

Peggy-Sue's cookies are the best in the world, or so I hear. She has been offered a job by Cookie Monster, Inc., to come to work at $160,000 per year. Currently, she is producing her own cookies, and she has revenues of $250,000 per year. Her costs are $80,000 for labor, $22,000 for rent, $40,000 for ingredients, and $5,000 for utilities. She has $300,000 of her own money invested in the operation, which, if she leaves, can be sold for $35,000 that she can invest at 20 percent per year. a. Calculate her accounting and economic profits.

Answer 1

Answer:

Accounting Profit =  103,000 Economic profit. =  (64,000)

Explanation:

ACCOUNTING PROFITS

Revenue .......... $250,000

Expenses:

Labor $80,000

Rent 22,000

Materials 40,000

Utilities  5,000

Total Costs........... $147,000

Net Profit                $103,000  

 

ECONOMIC PROFITS (1)

Revenue  .........................$250,000

Explicit

Labor $80,000

Rent 22,000

Materials 40,000

Utilities  5,000

Total Explicit Costs...... $147,000

Implicit Costs

Opportunity Cost of Working for Cookie Monster $160,000

Opportunity Cost of Owner's Capital ($35,000 X 20%)  7,000

Total Implicit Costs                                                  $167,000

Total Explicit Plus Implicit Costs $147,000  + $167,000 = $314,000

Economic Profit = 250,000 - 314,000 = ($64,000)

Peggy Sue is better off working for herself and should not work for Cookie Monster, Inc.

Answer 2

Answer:

Accounting profit $103,000

Economic profit(loss here) is -$64,000

She should rather take the job at Monster Inc as she is not enjoying an economic profit

Explanation:

In this question, we are asked to calculate the economic and accounting profits for Peggy-sue’s cookies. We proceed as follows;

Accounting profit(I.e profit without opportunity cost) = 250,000 - 80,000 - 22,000 - 40,000 - 5,000 = $103,000

The Economic profit(profit with opportunity cost) = Accounting Profit - opportunity cost

Let’s calculate the opportunity cost;

Opportunity cost = 160,000( her salary I’d she was working with Monster Inc) + 35,000 * 20%( her investment if she leaves the company) = 160,000 + 7,000 = 167,000

Her Economic Profit = 103,000 - 167,000 = -64 000( a loss in this case)