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Calculating Implicit and Explicit Costs

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At the beginning of the year, an audio engineer quit his job and gave up a salary of $175,000 per year in order to start his own business, Sound Devices, Inc.,The new company builds, installs, and maintains custom audio equipment for businesses that require high-quality audio systems. A partial income statement for Sound Devices, Inc., is shown below:

2010
---------
Revenues
Revenues from sales of product and services.....................$970,000
Operating costs and expenses
Cost of products and services sold ..........................................355,000
Selling expenses ....................................................................155,000
Administrative expenses ......................................................... 45,000
--------------
Total operating costs and expenses $555,000
income from operations .........................................................$415,000
interest expense (bank loan) .................................................. 45,000
Legal expenses to start business ............................................. 28,000
Income taxes ....................................................................... 165,000
------------------
$177,000
------------------

To get started, the owner of Sound Devices spent $100,000 of his personal savings to pay for some of the capital equipment used in the business. In 2010, the owner of Sound Devices could have earned a 15 percent return by investing in stocks of other new businesses with risk levels similar to the risk level at Sound Devices.

a. What are the total explicit, total implicit, and total economic costs in 2010?
b. What is accounting profit in 2010?
c. What is economic profit in 2010?
d. Given your answer in part c, evaluate the owner's decision to leave his job to start Sound Devices.

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Solution Summary

Solution describes the steps to calculate implicit costs, explicit costs, accounting profit and economic profits in the given case in 198 words.

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a. What are the total explicit, total implicit, and total economic costs in 2010?

Explicit costs are costs for which actual payments are made.

Total operating costs and expenses=$555,000
Interest paid=$45000
Legal expanses=$28000
Income taxes=$165000
Total explicit costs=Total operating costs and expenses+ Interest paid+ Legal expanses +Income taxes
...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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