I got a lot of problems with this exercise. I really hope you can help me. Thanks!
Samantha Roberts has a job as a pharmacist earning $30.000 per year, and she is deciding whether to take another job as the manager of another pharmacy for $40.000 per year or to purchase a pharmacy that generates a revenue of $200.000 per year. To purchase the pharmacy Samantha would have to use her $20.000 savings and borrow another $80.000 at an interest rate of 10 percent per year. The pharmacy that Samantha is contemplating purchasing has additional expenses of $80.000 for supplies, $40.000 for hired help, $10.000 for rent, and $5.000 for utilities. Assume that income and business taxes are zero and that the repayment of the principal of the loan does not start before three years
a) What would be the business and economic profit if Samantha purchase the pharmacy? Should Samantha purchase the pharmacy?
The business profit Pb is the revenue of the firm minues the explicit costs. Thus
Pb = $(200.000 – 80.000 – 40.000 – 10.000 – 5.000) = $65.000
The economic profit Pe is the business profit minus the implicit costs. She could earn $40.000 per year as manager. This gives us that
Pe = Pb - $40.000 = $(45.000 – 40.000) = $25.000
Since there is an economic profit she should do so.
b) Suppose that Samantha expects that another pharmacy will open nearby at the end of three years and that this will drive the economic profit of the pharmacy to zero. What would the revenue of the pharmacy be in three years?
I'm lost
c) What theory of profit would account for profits being earned by the pharmacy during the first three years of operation?
I'm lost
d) Suppose that Samantha expects to sell the pharmacy at the end of three years for $50.000 more than the price the paid for it and that she requires a 15 percent return on her investment. Should she still purchase the pharmacy?
I'm lost
a) What would be the business and economic profit if Samantha purchase the pharmacy? Should Samantha purchase the pharmacy?
The business profit Pb is the revenue of the firm minues the explicit costs. Thus
Pb = $(200.000 – 80.000 – 40.000 – 10.000 – 5.000) = $65.000
The economic profit Pe is the business profit minus the implicit costs. She could earn $40.000 per year. This gives us that
Pe = Pb - $40.000 = $(45.000 – 40.000) = $25.000
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What would be the business and economic profit if Samantha purchase the pharmacy? Should Samantha purchase the pharmacy?
The business profit Pb is the revenue of the firm minues the explicit costs. Thus
Pb = $(200.000 – 80.000 – 40.000 – 10.000 – 5.000) = $65.000
The economic profit Pe is the business profit minus the implicit costs. She could earn $40.000 per year. This gives us that
Pe = Pb - $40.000 = $(45.000 – 40.000) = $25.000
Since there is an economic profit she should do so.
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Suppose that Samantha expects that another pharmacy will open nearby at the end of three years and that this will drive the economic profit of the pharmacy to zero. What would the revenue of the pharmacy be in three years?
I'm lost here
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What theory of profit would account for profits being earned by the pharmacy during the first three years of operation?
Lost here too
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Suppose that Samantha expects to sell the pharmacy at the end of three years for $50.000 more than the price the paid for it and that she requires a 15 percent return on her investment. Should she still purchase the pharmacy?
Lost here too!
Sorry. The site refused to post some of it so it got a bit messy. As you can see I have answered the first part of the exercise, but I am still not sure about this part either.
First, in part a) you forgot about the interest expenses. As an explicit cost, she has to pay 10% of the 80,000 loan or 8,000 per year. In addition she has foregone interest income of $2000 per year.
I am confused by "theory of profit" other that what you explicitly stated. You calculated both economic profit and accounting profit. Am I also missing something?
Part c) She pays $100,000 for the pharmacy (20,000 of her own money plus 80,000 borrowed). 15% compounded annually is (1.15)^3 = 1.521. She needs an economic rate of return to exceed $52,100. Since the increase sales price of $50000 plus her annual economic profits (discounted) exceed 52,100, I believe she should still purchase the pharmacy.
There are 5 theties of profit: Risk Bearing, Frictional, monopoly, innovation, and Managerial efficiency.
a) To calculate the business profit, we need to subtract all the explicit costs from the revenue of the pharmacy:
Business Profit (Pb) = Revenue - Explicit Costs
Pb = $200,000 - ($80,000 + $40,000 + $10,000 + $5,000)
Pb = $200,000 - $135,000
Pb = $65,000
To calculate the economic profit, we need to subtract the implicit costs (opportunity cost) from the business profit. In this case, the opportunity cost is the income Samantha could earn as a manager of another pharmacy:
Economic Profit (Pe) = Business Profit - Implicit Costs
Pe = $65,000 - $40,000
Pe = $25,000
Since there is a positive economic profit, Samantha should purchase the pharmacy.
b) To determine the revenue of the pharmacy in three years, we need to consider that economic profit is expected to become zero due to competition. This implies that the revenue will equal the explicit and implicit costs:
Revenue = Explicit Costs + Implicit Costs
Revenue = $135,000
c) The theory of profit that would account for profits being earned by the pharmacy during the first three years of operation is the theory of monopolistic competition. During this period, the pharmacy is able to earn profits because it faces limited competition and can set higher prices due to the absence of close substitutes.
d) To decide whether Samantha should still purchase the pharmacy, we need to compare the expected return from selling the pharmacy after three years with her required return on investment. The expected return from selling the pharmacy is the profit from the sale, which is the difference between the selling price and the initial price:
Profit from Sale = Selling Price - Initial Price
Profit from Sale = $50,000
The required return on investment is Samantha's desired rate of return, which is 15% of her investment:
Required Return on Investment = 15% of Investment
Required Return on Investment = 0.15 * ($20,000 + $80,000)
Required Return on Investment = $15,000
If the expected profit from the sale is greater than the required return on investment, Samantha should still purchase the pharmacy. Otherwise, it would not be a profitable investment. In this case, the expected profit from the sale is $50,000, which is greater than the required return of $15,000. Therefore, Samantha should still purchase the pharmacy.