Question

1)    Your family purchased 118 Mulberry Street, New York City in the late 19^th century (approximately 1882) when that area was known as "Little Italy" and the area was primarily the home for Italian immigrants. A member of your family has continuously owned that building since then. The original purchase price was $ 4,250. There has not been a mortgage on the building for many years.

2)    Your immediate family now controls the building through inheritance. The only costs are building maintenance, taxes and insurance. The rent from the floors above street level provides sufficient income to pay all of the operating expenses of the building, and any overage goes to the senior members of the family.

3)    You and your siblings decide that you want to go into the gifts and souvenir business. Based on the location of the building (just off the corner of Canal Street, which is the main traffic street for that area) you all feel that this business will produce significant profits.

4)    After a few years in business, you and your two siblings are enjoying the fact that the business is very profitable, earning $ 300,000 per year in Net Pre-Tax Profits, which you split evenly as personal compensation as all three siblings spend most of their awake time on site, at the store.

5)    Therefore each of you makes $ 100,000 per year.

a.    You have calculated that each of you are working 50 weeks of the year, 7 days per week and approximately 14 hours per day. (98 hours per week.)

                                              i.    What is the hourly pay rate for the siblings? Calculate this two ways. REAL and NOMINAL.

1.    Assume that all personal expenses such as transportation, meals and health care and personal insurance are paid by each sibling.

6)    At the end of the fourth year, you read a write up on-line on something called "Economic Profits". Effectively, this method of profit calculation takes into account economic alternatives to current management financial decisions and compares what is to what could be.

7)    Based on that you and your two siblings make the following analysis to calculate Economic Profits for your business.

8)    ECONOMIC PROFIT CALCULATION:

a.   First the Facts:

b.    Current Rent (CR) for the ground floor space (1500 sq. ft.) = $ 0/Month = $ 0 annual rent

c.     Market Rent (MR) for ground floor space is $ 150 sq. foot per year= $ 225,000 per year.

d.    Current income (CI) per sibling = $ 100,000/yr. for a 7 day work week with 2 weeks' vacation  (based on $ 300,000/yr. profit). (See Paras. 4 & 5 above).

e.    Job replacement income (RI) per sibling (avg.) = $ 80,000/year for a 5 day work week for 52 weeks with two weeks paid vacation and a full range of health and insurance benefits paid for by the new employer.

                                              i.    Replacement Job requires 60 hours of work per week.

                                             ii.    Benefits are worth $ 20,000 per year with no employee contributions and no income tax impact.

                                            iii.    Everyone's tax rate is 50%.

                                            iv.    Replacement Job Benefits are tax-exempt.

HERE ARE THE QUESTIONS:

f.     What is the ECONOMIC RENT OF THE STORE?

g.    What is The ANNUAL ECONOMIC INCOME FOR THE THREE OF THEM (COMBINED) FOR THE ACTIVITY OF RUNNING THE STORE?

                                             i.    What about benefits?

h.   What is the hourly wage differential?

WHAT IS THE ECONOMIC PROFIT (OR COST) OF THE SOUVENIR SHOP???

i.     THIS IS FOR ALL THREE SIBLINGS

j.     Create a line item analysis that includes all of the cost and income factors that you feel are important.

BASED ON THE ABOVE ANALYSIS, WHAT WOULD YOU DO AND WHY???????

Do you need more information to make this decision and what are the risks involved with this decision??

Answer 1

As per the information and values provided in the question above,

Original purchase price of the property = $4250,

However, the siblings attained it as a part of inheritance,

The Net Pre-Tax Profits for each of the siblings = $300,000/3 = $100,000/year

Each of the siblings work for 7 day a week and 14 hours a day and 50 weeks a year,

So, every week they work for = 14*7 = 98 hours

Every year, each of the siblings work for 50 weeks = 98*50 = 4900 hours

Q. 5. a. i) Nominal pay rate is the rate of pay that employees recieve which do not take into account changes in prices, i.e. inflation. These are wages which are expressed in the form of money.

So, here, the nominal pay rate for each of the siblings = 100,000/4900 = $20.4/hour

Now. when it comes to real terms, real wages are the pay rates which have been adjusted for inflation. They are expressed in the amount of goods and services that can be bought. To calculate the real wage rate,

we divide the nominl hourly wage rate by the CPI or level of price and multiply the value by 100,

CPI i.e. Consumer price index is the measure of the average cost of a specific basket of consumer goods and services.

Real wage can also be determined by the formula: (Old wage* New CPI)/Old CPI,

However, in this question, there is no such information regarding the inflation rate or CPI given, and hence it is not possible to answer the real hourly pay rate.

f. Economic Rent is that extra money or payment that is earned by a resouce, such as land, labour, capital etc. owing to it present use. It is the positive difference between the actual payment and the payment that was expected in the first place. In this case,

Economic rent of land:

Difference between market rent and current rent:

Market rent for 150 sq foot per year = $225,000/year

The shop has a space of 1500 sq foot,

So, market rent = $225,000*10 = $2250,000/year

Current rent = $0 as the siblings own the space,

Therefore, the economic rent of land = $225,000/year

Now, Economic rent of Labour:

Each of the siblings work for 98 hours a week, earning = $100,000/ year ,

If they would work for 60 hours a week, for 50 weeks a year, they would earn = hourly wage rate that we determined in part a)i) $20.4/hour * 60 *50 hours = $61,200/year

After the 50% tax cute, they would earn = $30,600/year

In case of replacement job, 60 hours of work a week would have earned them = $80,000/year,

After the 50% tax cute, this would yield = $40,000/year

However, they would have also get $20,000/year worth of benefits which are tax exempt,

So, total they would get = $60,000/year

Therefore, economic rent is more in case of replacement job here, = $(60,000-30,600)/year

= $29,400/ year = opportunity cost i.e. the cost that each of the sibings are inquiring when they choose to run the store instead of taking the replacement job

Therefore, the economic rent of the store = economic rent of land = $225,000/year as shown above

g) The economic income for the three of the siblings combined/year = $300,000 minus the 50% tax cut

= $150,000/year

i) Information about benefits is only provided in the case of the job replacement income where $20,000 worth of benefits are provided each year.

h) Economic cost is referred to the opportunity cost insurred by the each of three siblings i.e. $29,400/ year as shown above. Combined value = 3 times the above value = $88,200

Only answered the first 4-5 sub parts acoording to the rules.

Thank You.