Question

You manage a real estate investment company. One year ago, the company purchased 10 parcels of land distributed throughout the community for $ 10.6 million each. A recent appraisal of the properties indicates that five of the parcels are now worth $8.4 million each, while the other five are worth $16.0 million each. Ignoring any income received from the properties and any taxes paid over the year, calculate the investment company’s accounting earnings and its economic earnings in each of the following cases:

1. The company sells all of the properties at their appraised values today.
2. The company sells none of the properties.
3. The company sells the properties that have fallen in value and keeps the others.
4. The company sells the properties that have risen in value and keeps the others.

(Negative amounts should be indicated by a minus sign. Enter your answers in millions.)

Answer 1

Answers-

10 parcels of land purchased at amount = $ 10.6 million
After appraisal 5 pacels of land are worth = $ 8.4 million
After appraisal 5 other parcels of land are worth = $ 16.0 million

a) Selling all the properties at appraised values today

Accounting earnings = total appraised values - original values
Total appraised values = $ 16.0 x 5 + $ 8.4 x5 = $ 80 + $ 42 = $ 122
Original value of all parcels of land = $ 10.6 x 10 = $ 106
Accounting earnings = $ 122 - $ 106 = $ 16

Economic profit is knowing the value of an asset if it was sold at a given time whether the sale has taken or not or whether the gain or loss is realized or not.

Economic earnings  = $ 16

b) No sale takes place

Accounting earnings = $ 0 as no sale takes place
Eonomic earnings = $ 16 as there changes in prices after appraisal though they are not realized.

c) Sells the properties that have fallen in value and keeps the others

Sells properties of $ 8.4 x 5 = $ 42
Their original value = $ 10.6 x 5 = $ 53

Accounting earnings = $ 42 - $ 53 = - $ 11

Economic earnings = - $ 11 + ($ 80 - $ 53) = - $ 11 + $ 27 = $ 16 as it is the maesure in change in values

d) Sells the properties which have risen in value and keeps the others

Sells properties of $ 16.0 x 5 = $ 80
Their original value = $ 10.6 x 5 = $ 53

Accounting earnings = $ 80 - $ 53 = $ 27

Economic earnings = $ 27 - ( $ 42 - $ 53) = $27 - $ 11 = $ 16 as it relolves around rocognition of income with or without sale.

We can observe that the Economic earnings are same in all the cases ie. $ 16