Question

1. EXPLICIT AND IMPLICIT COSTS An annual income statement from Quest Realty, Inc. is shown below: Revenues Revenue from sales of goods and services.............................. $80,000,000 Operating costs and expenses: Cost of products and services sold .......................................... $30,000,000 Selling expenses.......................................................................... $3,000,000 Administrative expense............................................................. $4,000,000 Total operating costs and expenses .................................. $37,000,000 Income from operations.................................................................... $43,000,000 Interest expense (corporate bonds & loans)................................... $300,000 Non-recurring expense (Legal expenses/fines in settling a federal antitrust suit.................................................. $200,000 Income taxes....................................................................................... $700,000 Net income ......................................................................................... $41,800,000 During this year of operation, Quest Realty owned and occupied an office building in downtown Indianapolis. For this year, the building could have been leased to other businesses for $2,000,000 in lease income. Quest Realty also owned undeveloped land valued at $15,000,000. Owners of Quest Realty can earn a 14% rate of return annually on funds invested elsewhere.

Detail each of the items that make up the explicit costs for Quest Realty. Why are they explicit?

Detail each of the items that make up the implicit costs for Quest Realty for this year. Why are they implicit?

Over the next three years, a firm is expected to earn the economic profit of $50,000 in the first year, $60,000 in the second year, and $90,000 in the third year. After the end of the third year, the firm goes out of business.

What would happen to the value of the firm if the adjusted discount rate went from 8 to 12 percent?

What does the discount rate increase mean?

Answer 1

1. Explicit costs are out-of-pocket costs for a firm—for example, payments for wages and salaries, rent, or material.

Details of Items that makes up the explicit cost are:

Cost of Goods Sold$30,000,000

Selling Expenses$3,000,000

Administrative Expenses$4,000,000

Interest Expenses$300,000

Non Recurring Expenses$ 200,000

Total Explicit Cost : $ 37,500,000

1. Implicit costs are the opportunity cost of resources already owned by the firm and used in business—for example, expanding a factory onto land already owned.

                   Details of Items that makes up the Implicit cost are:

                   Lease Income            $ 2,000,000

                   If funds are invested anywhere else other than land : $15,000,000*14% =           $2,100,000

                   Total Implicit Cost : $ 4,100,000