Question

John was a high school teacher earning $ 80,000 per year. He quit his job to start his own business in pizza catering. In order to learn how to run the pizza catering business, John enrolled in a TAFE to acquire catering skills. John’s course was for 3 months. John had to pay $2,000 as tuition for the 3 months.

After the training, John withdrew $110,000 from his savings account. He had been earning 5 percent interest per year for this account. He also borrowed $50,000.00 from his friend whom he pays 6 percent interest per year. Further, to start the business John used his own premises. He was receiving $12,000 from rent per year. Finally, to start the business John uses $50,000 he had been given by his father to go on holiday to USA.

John’s first year of business can be summarised as follows:

Item	Amount $
Revenue- Pizza Section	400,000
Revenue- Beverages Section	190,000
2 Cashiers (wages per worker)	55,000
Pizza ingredients	50,000
Manager	75,000
3 Pizza bakers (wages per baker)	60,000
Equipment	10,000

                    

Based on your calculated accounting profit and economic profit, would you advise John to return to his teaching job? Show your work                       

Answer 1

Accounting costs are explicit cost that require monetary payment.

Explicit costs :

Wages for cashiers= $55,000

Pizza ingredients= $50,000.

Manager= $75,000.

3 pizzas bakers= $60,000

Equipment= $10,000.

Training cost= $2,000

Interest on borrowed money (6% on $50,000)=$3,000.

Total explicit costs $55,000 +$50,000+$75,000+$60,000+$10,000+$2,000+$3,000=$255,000

Revenue=

Revenue- Pizza Section	400,000
Revenue- Beverages Section	190,000 590,000.

a) Accounting Profit= Revenue- explicit costs= $590,000 - $255,000=$ 335,000.

b) Implicit or opportunity costs do not require actual monetary payments. Implicit costs are opportunity costs. Opportunity cost is the value of the next best alternative.

Implicit costs:

Salary foregone= $80,000 per year.

5% on $110,000 on savings=$5,500.

Rent foregone= $12,000.

Total implicit cost= $80,000 + $5,500 + $12,000 =$97,500.

Economic profit= Accounting profit-implicit costs.

                        =$ 335,000- $97,500= $237,500.