Question

Factory X who has a product with a selling price of $ 500 and annual sales of 6,000 units. Fixed costs are $ 40,000 and variable costs are $ 150,000 (both annually). Owners of Factory X could invest in an alternative business, Factory C in which they will have a profit of $ 150,000.

What is the accounting profit of Factory X business?

What is the economic profit of Factory X business?

Answer 1

Selling price = $500 per unit

Annual sales = 6,000 units

Calculate the Total Revenue -

Total Revenue = Selling price * Annual sales = $500 * 6,000 = $3,000,000

The total revenue is $3,000,000.

Fixed cost = $40,000

Variable cost = $150,000

Calculate the Total Cost -

Total Cost = Fixed cost + Variable cost = $40,000 + $150,000 = $190,000

The Total Cost is $190,000.

Calculate the accounting profit -

Accounting profit = Total Revenue - Total Cost = $3,000,000 - $190,000 = $2,810,000

Thus,

The accounting profit of Factory X business is $2,810,000.

The owner of Factory X can invest the amount he is using in his own business in Factory C and could earn a profit of $150,000.

This means the opportunity cost of funds invested in business for owner of Factory X is $150,000.

Calculate the economic profit -

Economic profit = Accounting profit - Opportunity cost

Economic profit = $2,810,000 - $150,000 = $2,660,000

Thus,

The economic profit of Factory X is $2,660,000.