Suppose that a small clothing store at the mall had $250,000 in sales. The cost

Question

Suppose that a small clothing store at the mall had $250,000 in sales. The cost of goods sold was $100,000. The owner could have earned $40,000 by working for someone else in the same mall. The owner invested $100,000 in the business, and the interest rate on savings at the bank is 10%. Rent was $10,000 and taxes and licenses cost the business $16,000. The owner eats in the store and pays $10,000 for her lunch and dinner. She pays $5,000 to commute to and from the store. If she worked for someone else, she would work the same shift that she does running the small clothing store and would spend the same amount on lunch and dinner. What was the economic profit for the business?

Explanation / Answer

Economic profit also looks at the opportunity cost of capital.

Opportunity cost = 40,000 + 10% of $100,000 = $50,000 (i.e. sum of salary he would have earned + interest on investment that has been forgone)

Economic profit = Sales – COGS -Rent - License costs - Owner lunch –commuting cost – Capital cost - opportunity cost
                                = 250,000 - 100,000 - 10,000 - 16,000 -10000– 5000 – 100,000 - 50000
                                = - $31,000

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