##### Please check answers, especially Economic Profit. Integrating-(Answered)

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?have attached a file for someone to double check answers.

Please check answers, especially Economic Profit.

Integrating problem. 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 generate 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 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 purchased the pharmacy?

Answer a)

Business profit = total revenue ? total business cost (or explicit cost)

= revenue ? supplies ? interest on loan ? utilities ? hired help ? rent

= 200000- 80000 - (80000*0.1) ? 5000 ? 40000 -10000

= $57000

Economic profit = business profit - interest rate forgone on saving amount ? opportunity cost of

purchasing pharmacy

= 57000 - (20000*0.1) - 40000= $15000

Samantha should purchase the pharmacy because economic profit is positive

b. Supposed that Samatha 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?

Answer b)

If revenue is equal to economic cost economic profit would be zero.

Economic cost = interest on loan + supplies + rent + utilities + interest rate forgone on saving amount +

hired help + opportunity cost of purchasing pharmacy = $185000

Revenue per year would be $185000

c. What theory of profit would account for profits being earned by the pharmacy during the first 3 years

of operation?

Answer c)

In the given case Samantha Jones is having no competitors in initial three years. She is operating alone

and there is no nearby competitor. It is theory of monopoly in which Samantha earned handsome

business and economic profits.

d. Suppose that Samatha expects to sell the pharmacy at the end of the 3 years for $50,000 more than

the price she paid for it and that she requires a 15 percent return on her investment. Should she still

purchase the pharmacy?

Answer d)

(1)

If Samantha sells the pharmacy after three years she is expected to get

50000+20000*0.15+80000*(Interest to be received - interest to be paid)

= 50000+20000*0.15+80000*(0.15-0.10) = $57000

Her total net payoff from purchasing the pharmacy = Profit earned over three years + Sale price received

= (15000*3)+57000 = 45000 + 57000 = $102,000.

However, if Samantha had worked as manager, she could have earned $120000 (40000*3) after 3 years.

Hence, Samantha should work as manager instead of purchasing the pharmacy.

(2)

From my reading of the question, her investment is her savings plus the amount borrowed. The interest

paid on the amount borrowed is a variable cost and not part of her investment.

Thus, the amount she expect to get will be = 50000 + [(20000+80000)*0.15] = 50000+(0.15*100,000) =

50000+15,000 = $65000.

Her total net payoff from purchasing the pharmacy = Profit earned over three years + Sale price received

= (15000*3)+65000 = 45000 + 65000 = $110,000.

However, if Samantha had worked as manager, she could have earned $120000 (40000*3) after 3 years.

Hence, Samantha should work as manager instead of purchasing the pharmacy.

Note:

1. P15(d): Compare the present value of economic profit in each of the next three years and the loss of

$50,000 in the third year using 15% as the discount rate.

Assuming that profits are earned at the end of each year, we have,

Net Present value of future profits/losses = PV of profit earned at the end of 1 st year + PV of profit

earned at the end of second year + PV of loss incurred at the end of 3 rd year

= [15000/(1+0.15)] + [15000/(1+0.15)2] + [-50000/(1+0.15)3]

= 13043.48 + 11342.16 ? 32875.81 = (-) $8490.17

Paper#9256185 | Written in 27-Jul-2016

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