In: Economics
Please show all work in full detail.
You have been working for your brother (owner of a Down Under Sandwich Shoppe). The franchise company is now offering you a chance to franchise one of their new Big Bird Stick-e-Chicken shops (which sells their honey-roasted chicken-on-a-stick). You estimate your business can gross 45% of Down Under’s $500,000 sales. Shop space is available between Down Under Sandwiches and Little Nero Salads that leases $8,400 a year plus a yearend rent bonus to the property owner of 3% of your gross sales in excess of $200,000. You intend to invest $20,000 of your own savings (which is presently earning you 6% per annum interest). A bank will loan you $100,000 (annual interest on this loan will be $7000). NOTE: neither the bank loan principle you borrow from the bank nor the $20,000 of your own money you invest is an explicit or implicit cost. However, the interest paid on the bank loan is explicit, and the interest foregone on your savings is implicit. You estimate that hired labor will cost you $70,000 a year, utilities $5,900 a year, and ingredients for the food $100,000 a year. You will have to pay Big Bird, Inc., an annual franchise fee is $3,000 plus 2% of your gross sales for the year. Another 1% of gross sales must be paid for national advertising. You are presently an Assistant Manager at Down Under earning $12,000 a year plus a yearend bonus of 2% of gross (a job you will have to give up), but you do not think you can earn more than this working for yourself.
What is the estimated explicit (accounting) cost of your proposed business? Itemize in detail.
What is the accounting profit you project for your business?
What is the total implicit cost you estimate for your venture? Itemize in detail.
Do you project any economic profit? How much?
What is the annual interest rate the bank will charge you for its loan?
From the profit viewpoint, would this be a viable business to start? Explain:
Please show all steps to get to answer.
Question 1
Gross sales of proposed business = 45% of $500,000 sales of Down under = 0.45 * 500000 = 225,000
Following are the explicit cost of business -
Rent of shop = 8400 + (3% of gross sales) = 8400 + (0.03 * 225000) = 8400 + 750 = 9,150
Annual interest of loan taken = 7000
Annual franchise fee = 3000 + (2% of gross sales) = 3000 + (0.02 * 225000) = 3000 + 4500 = 7500
Paid for national advertising = 1% of gross sales = 0.01 * 225000 = 2250
Labor cost = 70000
Utilities = 5900
Ingredients for food = 100000
Calculate the total estimated explicit cost -
Total explicit cost = rent of shop + annual interest of loan taken + annual franchise fee + paid for national advertising + labor cost + utilities + ingredients for food
Total explicit cost = 9150 + 7000 + 7500 + 2250 + 70000 + 5900 + 100000 = 201800
The total estimated explicit cost of the proposed business is $201,800.
Question 2
Calculate the accounting profit -
Accounting profit = Gross sales - total explicit cost
Accounting profit = 225000 - 201800 = 23200
The accounting profit of proposed business is $23,200.
Question 3
Following are the implicit costs of the proposed business -
Foregone interest = 0.06 * 20000 = 1200
Foregone salary = 12000 + (2% of gross sales of Down Under) = 12000 + (0.02*500000) = 12000 + 10000=22000
Total implicit cost = Foregone interest + Foregone salary = 1200 + 22000 = 23200
The total implicit cost estimated for the venture is $23,200.
Question 4
Calculate the economic profit -
Economic profit = Gross sales - explicit cost - implicit cost = 225000 - 201800 - 23200 = 0
The economic profit is $0.
Question 5
Loan taken = 100000
Interest paid = 7000
Interest rate = 7000/100000 = 0.07 or 7%
The annual interest bank will charge for its loan is 7 percent.
Question 6
A business is said to be viable business if economic profit is either positive or zero.
In given case, economic profit is zero. This means both explicit and implicit costs are being recovered.
So, from profit pint of view, this would be a viable business to start.