Question

You manage a real estate investment company. One year ago, the company purchased 10 parcels of land distributed throughout the community for $11.6 million each. A recent appraisal of the properties indicates that five of the parcels are now worth $9.4 million each, while the other five are worth $17.4 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:

The company sells all of the properties at their appraised values today.
The company sells none of the properties.
The company sells the properties that have fallen in value and keeps the others.
The company sells the properties that have risen in value and keeps the others.
Case Accounting Income (million) Economic Income (million)
a. b. c. d.

Answer 1

To determine the company's earnings, accounting earnings are calculated by subtracting the original purchase costs from the appraised sale values, resulting in $18 million when all properties are sold. There are no earnings when no properties are sold. If only the depreciated or appreciated properties are sold, the earnings are -$11 million and $29 million, respectively.

Step-by-step explanation:

To calculate the accounting earnings and economic earnings for the real estate investment company in the given scenarios, we will follow two fundamental steps. Firstly, we identify the total revenues and secondly, we deduct the explicit and implicit costs, where applicable, to determine both types of earnings.

Scenario a: Selling All Properties

Accounting Earnings = (5 × $9.4 million) + (5 × $17.4 million) - (10 × $11.6 million)
= $47 million + $87 million - $116 million
= $18 million

Economic Earnings = Accounting Earnings (As there are no additional implicit costs to consider)
= $18 million

Scenario b: Selling No Properties

Since the company sells none of the properties, there are no revenues obtained from sales, hence, Accounting Earnings = $0.
Economic Earnings also equal $0 assuming there are no implicit costs or benefits.

Scenario c: Selling Properties that have Fallen in Value

Accounting Earnings = (5 × $9.4 million) - (5 × $11.6 million)
= $47 million - $58 million
= -$11 million (Accounting Loss)

Economic Earnings = Accounting Earnings
= -$11 million

Scenario d: Selling Properties that have Risen in Value

Accounting Earnings = (5 × $17.4 million) - (5 × $11.6 million)
= $87 million - $58 million
= $29 million

Economic Earnings = Accounting Earnings
= $29 million