Question

Two university graduates, Bill and Steve, worked for an advertising agency at an annual salary of $40,000 each for 3 years after they graduated. Then, they decided to quit their jobs and start a partnership that designs and builds Web sites. They rented an office for $12,000 a year and bought capital for $30,000. To pay for the equipment, Bill and Steve borrowed money from a bank at an annual interest rate of 6 percent. During their first year of operation, the partners' total revenue was $100,000. The market value of their capital at the end of the year was $20,000. If Bill and Steve do not design Web pages, their best alternatives are to return to their previous job. A. What is the firm's economic depreciation

Answer 1

To determine the profitability of Eryn's legal practice, we must subtract both explicit ($85,000 for office rental and law clerk's salary) and implicit costs (foregone salary from her current job) from her expected annual earnings of $200,000. Only if the remainder exceeds her current salary can the practice be considered economically profitable.

Step-by-step explanation:

To assess whether Eryn's legal practice would be profitable, we need to consider both her explicit and implicit costs. The explicit costs include the office rental and the law clerk's salary, which add up to $85,000 per year. However, we also must account for implicit costs, which are the opportunity costs of forgoing her current job at a corporate law firm to start her own practice. If her current job pays a salary that is similar to, or more than, the anticipated earnings from her own practice, she might incur a loss when considering the implicit costs.

Economic profit is calculated by subtracting both explicit and implicit costs from total revenue. If Eryn's revenue from running her own legal practice exceeds $200,000, and her only explicit costs are the rental and clerk's salary totaling to $85,000, she would have to compare her current salary with the remaining amount to determine if there is an economic profit. If the net amount is greater than her current salary, her practice would be economically profitable.

Answer 2

$11,800

Step-by-step explanation:

When we calculate economic costs, we must include opportunity costs. Opportunity costs are the extra costs or benefits lost from choosing one activity or investment instead of another alternative.

In this case, Bill and Steve's total costs are $80,000 in lost salaries, interests paid for their credit (= $30,000 x 6% = $1,800), and $12,000 paid in rent.

The economic depreciation = the equipment's initial cost + interests paid - market value at the end of the year = $30,000 + $1,800 - $20,000 = $11,800