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March 25, 2017

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Hi,

Could you please help me with the following question?

Bob and Jane decide to open their own business selling ergonomically correct office furniture that Jane has designed. Assume they operate this business from leased office space near their home. Also assume that they lease their computer equipment and data base software. The actual production of the furniture is subcontracted to various commercial factories as customer orders arrive and the unassembled kits are shipped via UPS to clients throughout the U.S. Their target market is small businesses including those run out of home offices.
They have so much faith in the potential of Jane’s designs that they quit corporate jobs in marketing and MIS administration (which jointly had earned them $250,000 per year), and sink $500,000 (.5 million) of their own funds into this venture at the start of their first year to place advertising in trade journals and on the internet. (Assume this $500,000 had previously been invested in a diversified portfolio that had been averaging a 10% annual before tax rate of return.) At the end of the year they calculated that they had the following costs and revenues.

Total Revenues: $5.0 million

Costs:
Payments to furniture subcontractors $3.5 million

Shipping Costs $.1 million

Lease Payments on Office Space and Computer
Equipment &Software$.1 million

Overhead Expenses: Insurance, utilities etc. $.1 million

Advertising on Internet & Magazines
(Purchased at start of year)$.5 million

Additional Sales Expenses (phones,business travel,$.2 million
Entertaining clients etc.)

Total Listed Costs = $4.5 million

a) Is Bob & Jane's economic profit different from their accounting profit? If so, how much economic profit did they earn during this first year of operation?
b) What were Bob & Jane's fixed costs during their first year of operation ?

Thanks

  • Economics - ,

    Do a little research, then take a shot. Hint: accounting profit does not take into account opportunity costs. Hint 2:, fixed costs are costs the firm must pay regardless of output.

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