MS 6404 Managerial Economics

Student ID :

5772006

Student Name: Ausara

Saelim
Assignment 1
Problem solving: At the beginning of the year, an audio engineer quit his job and
gave up a salary of $175,000 per year in order to start his own business, Sound
Devices, Inc. The new company builds, installs and maintains custom audio
equipment for businesses that require high audio systems. A partial income
statement for Sound Devices, Inc. is as follow:
Year 2004
Revenue from sales of product and service

Total operating cost and Expenses

Income from operation

970,000
555,000

415,000

Interest expenses (bank loan)

45,000

Legal expenses to start business

28,000

Income taxes

165,000

Net income

177,000

To get started, the owner of Sound Devices spent $100,000 of his own personal
saving to pay for some of capital equipment used in the business. In 2004, the
owner could have earned 15% return by investing in stocks of the other new
businesses with risk level similar to risk level of Sound Devices.
a) What are the total explicit, total implicit, and total economic costs in
2004?
Answer:
Total explicit

Total operating cost and expenses + other

expenses (ex. Income Taxes, legal expenses and interest expenses)

=
$555,000 + 45,000 + 28,000 + 165,000
=
$793,000

Total implicit

Opportunity cost of owner-supplied

resources (possible salary in another job and expecting 15% investment

stock return)
=
$175,000 + 15,000
=
$190,000
Total Economic cost
=
Total explicit + Total implicit
=
$793,000 + 190,000
=
$983,000
b) What is the accounting profit in 2004?
Accounting profit=
Total revenue Total explicit cost
=
$970,000 793,000
=
$177,000
c) What is economic profit in 2004?
Economic profit =
Total revenue Total Economic cost
=
$970,000 983,000
=
-$13,000
d) Evaluate the owners decision to leave his job to start Sound Device.
Answer: The owner of Sound Devices, Inc. earned actually $2000 more
from his expected salary comparing to the net income of the company.
Even though after comparing economic profit, the owner of Sound
Devices, Inc. lost at -$13,000, but if we can see in the table above showing
legal expenses to start business which the owner will not need to pay for
the next coming years. Therefore, we can forecast for his future income
would be even greater than his expecting opportunity of owner-supplied
resources. In my opinion, the owner of Sound Devices, Inc. didnt make
the wrong decision. He should continue his business and once his business
is stabilized, he could find the solution of reducing other costs so he will
gain the maximizing profitably which will achieve his economic goal.