The revenues and costs of The Greener Way, a lawn care business wholly owned by

Question

The revenues and costs of The Greener Way, a lawn care business wholly owned by Mr. Albert Johnston are listed below. Lawn Mowing $63,000 Aeration $2,000 Labour Cost $30,000 Vehicle Costs $15,000 Lawnmower Maintenance $5,000 Debt-Service Costs $13,000 a) What is The Greener Way’s accounting profit? b) Suppose Mr. Johnston has $63,000 of capital invested in The Greener Way. Also suppose that the current return on an equally risky investment is 7%. What is the opportunity cost of Mr. Johnston’s capital? c) What are the economic profits for The Greener Way? d) If The Greener Way’s profits were typical of lawn care companies, what would you expect to happen to this industry? Explain.

Explanation / Answer

(a)

Total revenue of The Greener Way = $63,000

Total cost of The Greener Way = Aeration cost + Labor cost + Vehicle cost + Lawnmower maintenance + Debt-service cost

Total cost of The Greener Way = $2,000 + $30,000 + $15,000 + $5,000 + $13,000 = $65,000

Calculate the The Greener Way's accounting profit -

Accounting profit = Total revenue - Total cost = $63,000 - $65,000 = -$2,000

The Greener Way's accounting profit is -$2,000.

(b)

Capital invested in business = $63,000

Rate of return that can be earned = 7%

Interest that could be earned = $63,000 * 0.07 = $4,410

So, owner is sacrificing the interest of $4,410. Opportunity cost implies the cost of sacrifice made to undertake the particular task.

Here, the owner is sacrificing the interest of $4,410 by keeping the funds invested in business.

So, the opportunity cost of Mr. Johnston's capital is $4,410.

(c)

Calculate the economic profit of The Greener Way -

Economic profit = Accounting profit - Interest foregone = -$2,000 - $4,410 = -$6,410

The economic profits for The Greener Way is -$6,410.

(d)

The Greener Way is earning a negative economic profit.

In an industry, if the firms are earning a negative economic profit then in that case there is exit of the firms from the industry.

So, if the Greener Way's profits were typical of lawn care companies then in that case there will be exit of the firms from this industry.

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