A few years ago, a construction manager earning $70,000 per year working for a r

Question

A few years ago, a construction manager earning $70,000 per year working for a regional home
builder decided to open his own home building company. He took $100,000 out of one of his
investment accounts that had been earning around 6% a year and used that money to start up
the business. He worked hard the first year, hiring one employee (his only salary cost for the business
was the $40,000 paid to this employee), and generated total sales of $1,000,000. Total material
and subcontracted labor costs for the year were $900,000. Calculate accounting profit.
What are the opportunity costs for the manager of being in this business relative to returning
to his old job? What is the economic profit of the business?

Explanation / Answer

Opportunity cost of capital = 6% of 100,000 = 6,000
OPeration Cost (O.C) of the manager = $70,000
Salary paid to employee = $40,000
Total material and subcontracted labor cost = $900,000

The Economic profit = Total revenue - Total economic Cost

Total economic Cost = Administrative cost + Opportunity cost of the factors of production

Total economic cost = 6,000 + 70,000 + 40,000 + 900,000
= 1,016,000

Total revenue = $ 1,000,000

Opportunity cost of capital = 6% of 100,000 = 6,000

Economic Profit = 1,000,000 - 1,016,000
= -16,000

He's actually having an economic loss of $16,000

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