Before Sarah quit her job as a carpenter, she was earning $35,000 per year. She

Question

Before Sarah quit her job as a carpenter, she was earning $35,000 per year. She rented a building for $12,000 per year and opened a cabinet shop. She spends $148,000 per year for labor, materials, utilities, and advertising. (i) How much revenue will the business have to earn in order to break even in terms of business profit? (ii) How much revenue will the business have to earn in order to break even in economic terms? (iii) Now, suppose that Sarah needs operating cash, so she cashes in a $100,000 CD that was earning 5% per annum. Now, what happens to accounting and economic costs?

Explanation / Answer

Her accounting costs are 148,000+12,000= 160,000 per year so that's the amount of revenues she needs to break even in terms of a business profit. You have to add the opportunity cost of her previous earnings to get the economic costs so 160,000+35,000= 195,000, so that's the revenue she needs to break even in economic terms. Accounting costs don't change. However, the economic costs now include the foregone interest on her CD, or another 5,000.

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