Answer to Question #274664 in Finance for Dennis

Question

1. Anuradha Sharma, a start up entrepreneur from Bareilly,

has invested Rs 80 lacs in an apparel retail store. Business

has been good, and the store shows an accounting profit of Rs

10 lacs for the last year. This profit is after taxes and after

payment of a Rs 20 lacs salary to Ms. Sharma. This salary is

less than what she could make at another job, which is about

equal to Rs 40 lacs. Considering the risk involved in the

fashion retail business post Covid'19, she believes that a 15

percent after-tax rate of return is appropriate for this type of

investment. (20 marks)

a.

Given this information, calculate the economic profit

earned by Ms Sharma.

b.

What accounting profit would the firm have to earn

in order for the firm to break even in term of economic

profit?

Answer 1

a.

Economic profit = total revenue – ( explicit costs + opportunity costs)

Accounting profit = total revenue – explicit costs

Economic profit = Accounting profit - opportunity costs

opportunity costs are the profits that a business misses out on when choosing between alternatives.

we have:

opportunity costs:

difference in salaries = -30

15 percent after-tax rate of return = $-(10\cdot0.15)=-1.5$

so,

Economic profit = $10+30+1.5=41.5$

b.

break even in term of economic profit:

economic profit = 0

then:

Accounting profit = opportunity costs

Accounting profit = $-30-1.5=-31.5$