1)The Midnight hour, a local
nightclub, earned $100,000 in
accounting profit last year. This
year the owner, who had invested $ 1
million in the club, decided to
close the club. What can you say
about economic profit (and the rate
of return)in the nightclub business?
ANSWER:
Economic Profit = TR(total revenue)-
TC(total economic cost)
EP = $100,000 - $1,000,000
EP = -$900,000
Since EP is a negative number the
firm should shut down, the output is
not positive, therefore the company
operates at a loss, the manager
needs to determine how long they
want to continue with this loss
process.
Does this sound like the correct
answer?
Thanks,
EY
Certainly the owner didn't expect to make a million dollars the first year the club was in existence.
If the club continues to increase its revenues, then the owner would be better served for the club to stay in business and increase its profits each year.
To determine the economic profit of a business, you need to consider both the total revenue (TR) and the total economic cost (TC). Economic profit is calculated by subtracting the total economic cost from the total revenue.
In this case, the nightclub earned $100,000 in accounting profit, which represents the total revenue. However, you also need to take into account the total economic cost. The owner invested $1 million in the club, which is a significant cost.
So, let's calculate the economic profit:
EP = TR - TC
EP = $100,000 - $1,000,000
EP = -$900,000
After performing the calculation, we find that the economic profit is -$900,000. A negative economic profit indicates that the nightclub is operating at a loss. In this situation, it would be wise for the owner to consider shutting down the club since continuing to operate at a loss is not sustainable.
However, it's important to note that economic profit is just one aspect to consider when determining the success or failure of a business. Factors like long-term prospects, market conditions, and the potential for future growth should also be taken into account.
In summary, given the provided information, the correct answer is that the nightclub is operating at a loss with a negative economic profit of -$900,000.