Tomas quit his job at the Tri-City bank where he earned $50,000 a year to start
ID: 1200914 • Letter: T
Question
Tomas quit his job at the Tri-City bank where he earned $50,000 a year to start his own businesses, a bank marketing company. He estimates his entrepreneurial talent or forgone entrepreneurial income to be $5,000 a year. He used $100,000 in savings that earned 5 percent interest annually to finance the new business. In the first year, the firm earned revenue of $250,000. The costs for rent, supplies, and an employee’s salary were $200,000. What was the accounting profit for the new business? What was the economic profit (or loss)? Explain your calculations for both questions.
Explanation / Answer
Accounting Profit = Revenue - Costs = $250,000 - $200,000 = $50,000.
Accounting profit does not take into account the income or opportunity to earn income foregone. It just takes the profits and losses, the income and revenue visible.
Economic profit = Accounting profit - Salary foregone - Interest income foregone on capital employed
= $50,000 - $50,000 - $5,000 (5% of $100,000)
= Loss of $5,000.