Question

Please answer the questions below:

1. Sam quit a $30,000-a-year job with a local heating and air conditioning firm to go into business for himself. After his first year in business, his accountant showed him an income statement that indicated Sam’s firm had a profit of $40,000. During this year Sam had drawn a salary of $20,000.
a) What was Sam’s accounting profit, his entrepreneurial profit, and his opportunity cost?
b) Explain the difference between accounting and entrepreneurial profit.

2. You are going to open a business making custom cabinets. You can sell each cabinet for $80. It takes a cabinet-maker approximately 45 minutes to make one cabinet. Each cabinet-maker works an eight-hour day, earning $18 per hour. Each cabinet will use $25 in raw materials. You usually produce cabinets 20 days a month and can employ two cabinet-makers. You estimate that your fixed costs are $5,000 per month.
a) What is your contribution margin?
b) How many cabinets must you make each month to break even?
c) What is your total monthly revenue if you want to earn a $2,000 profit?

3. Jane James owns an appliance store. She normally receives $50,000 worth of appliances per month. She does not like to owe people money and always pays her bills on the day she receives the invoice. Someone told her that if she delayed payment, she could actually increase her profit because the money would be earning interest in her account. She went through her bills and found that she actually had an additional ten days, on average to pay her invoices. She also found that she was earning 5 percent interest on the money she had in her money market savings account.
a) If she delayed payment by ten days, how much additional interest would she earn for the year?
b) Explain how this problem represents a disbursement float.

4. Larry’s Lawn Equipment Company gives terms of 2/10, n/30. Larry has annual credit sales of $500,000 and average accounts receivable of $60,000.

a) What is Larry’s accounts receivable turnover?

b) What is Larry’s average daily collection?

c) What is the relationship between the terms that Larry is giving and his average daily collection?

Now calculate the following If Larry has accounts receivable of $100,000 rather than $60,000:

a) What is Larry’s accounts receivable turnover?
b) What is Larry’s average collection period?
c) What should Larry do, if anything?

Answer 1

PART-1.
a) --Sam’s accounting profit: 40,000

Working: Profit depicted on the income statement

--Sam’s entrepreneurial profit: 10,000

Working: 40,000 (accounting profit) - 30,000(opportunity cost) = 10,000

--Sam’s opportunity cost: 30,000

Working: Salary of $30,000 that Sam has foregone

b) Explain the difference between accounting and entrepreneurial profit

Accounting profit describes bottom line income after consideration of all expenditure for the option that was selected. Accounting profit does not make a comparison of multiple alternatives or strategies, rather it analyzes functions and profitability of the option in action. On contrary the entrepreneurial profit primarily focuses on opportunity costs. It determines what was gained or lost by choosing one option over the alternative.

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PART-2)

a) Solution: $41.5

Working: Price = $80; Variable costs = ($18 * 0.75 hour )+ $25 = $38.5

Contribution margin = $80 - $38.5 = $41.5

b) Solution: 121

Working: Fixed Cost = $5,000

Break-even (quantity) = $5,000 / $41.5 = 121 cabinets each month

c) Solution: $13,493.98

Working: (FC + Desired profit) / {1 – (VC / P)}

= ($5,000 + $2,000) / {1 - ($38.5 / $80)}

= $7,000 / 0.5187

= $13,493.98