Question

On January 1, 2020, Larkspur Co. leased a building to Crane Inc. The relevant information related to the lease is as follows. 1. The lease arrangement is for 10 years. The building is expected to have a residual value at the end of the lease of $3,400,000 (unguaranteed). 2. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value. 3. Lease payments are $250,000 per year and are made at the beginning of the year. 4. Crane has an incremental borrowing rate of 6%, and the rate implicit in the lease is unknown to Crane. 5. Both the lessor and the lessee are on a calendar-year basis. Click here to view factor tables. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Answer 1

The question seeks to determine the firm's economic profit for the previous year, by considering the forgone rent of $30,000 as an implicit cost. Economic profit is calculated by subtracting both explicit and implicit costs from the firm's total revenue.

Step-by-step explanation:

The question posed pertains to the calculation of the firm's economic profit for the previous year, continuing from Exercise 7.1. Economic profit is determined by accounting for both explicit and implicit costs. Explicit costs are out-of-pocket expenses, explicitly paid, such as wages and raw materials. Implicit costs, on the other hand, represent opportunity costs associated with a firm's use of resources that it owns and could have been put to some other use; for example, the factory land owned by the firm that could be rented out.

In the scenario provided, the implicit cost is the forgone rent of $30,000 per year that the firm could have earned from renting out the land. To calculate the economic profit, we need to subtract both explicit and implicit costs from the firm's total revenue. Without knowing the firm's total revenue and explicit costs from Exercise 7.1, we cannot calculate the exact amount. Therefore, we recognize that the firm's economic profit would be reduced by at least $30,000 due to the implicit cost of not renting out the land. If the firm's accounting profit was $100,000 (hypothetically), after considering the implicit cost of $30,000, the economic profit would be $70,000.It is important to understand that the concept of economic profit is crucial for making sound business decisions, as it provides a more comprehensive view of a firm's profitability by taking into account all associated costs.