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Homework #1 – Week #1
Q.1 (20 points) Sarah is currently working for an accounting consulting firm, and her
annual salary is $60,000. She is considering, however, to open her own business of
art gallery. If Sarah runs her own business, then she will have to give up the current
job in the firm. With the business, Sarah will provide the space for artists to display
their works, and when a piece of art is sold, she will receive a certain amount of fee
from the artist. She expects the business will generate $300,000 revenue per year,
and the expenses to run the business, which includes the lease, utility, etc., will be
$200,000. Compute the expected annual accounting and economic profits from the
business.
Answer:
The difference between the accounting and economic profits is that economic
profits consider implicit costs (opportunity costs) on top of the explicit. For that
reason, any cost as a result of forgone opportunity is accounted for. See the
calculation below.
Accounting profit = $300,000 - $200,000 = $100,000
Economic profic = $$300,000 - $200,000 - $60,000 (forgone opportunity) = $40,000
Q.2...