posted by Adam on .
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. Their lease agreements are for 1 year.
The actual production of the furniture kits 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 $300,000 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: $6.0 million
Payments to furniture subcontractors $4.0 million
Shipping Costs .1 million
Lease Payments on Office Space and Computer
Equipment &Software $ .5 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 = $ 5.4 million
a) What were Bob & Jane's fixed costs during their first year of operation ? Explain your answer. 3
b) Bob and Jane brag to their friends that their business earned a profit of $600,000 in its first year. Would an economist agree? Explain, and if not identify their economic profit level.
Do a little research and then take a shot, what do you think?
Hint a) fixed costs are costs the firm incurs regardless of the level of production/sales. Variable costs are directly related to the levelo of production/sales. Except for advertising, the cost listed are clearly fixed or variable. Whether advertising is a fixed cost or a variable cost is a topic for discussion and disagreement.
hint b: Think opportunity costs.
5.1 million for VC