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Calculating Accounting and Economic Profits - Sound Devices Inc.

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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, Sounds 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 show below:

Revenues
Revenue 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 expenses (bank loan): $45,000
Legal expenses to start business: $28,000
Income taxes: $165,000
Net income: $177,000

To get started, the owner of Sound Devices spent $100,000 on 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.

1. What is total explicit cost in 2007?

2. What is total implicit cost in 2007?

3. What is total economic cost in 2007?

4. What is accounting profit in 2007

5. What is economic profit in 2007?

6. Based on your answers to the previous questions, evaluate the owner's decision to leave his job to start Sound Devices.

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Solution Preview

1) What is total explicit cost in 2007?

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
= 555000+45000+28000+165000
= ...

Solution Summary

Solution describes the steps to calculate implicit cost, explicit cost, accounting profit and economic profit in the given case.

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Sound Device Inc

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 maintain custom audio equiptment for businesses that require high-quality audio systems. A partial income statement for Sound devices, inc, is shown below:
Revenue
Revenue from sales of products and services 970,000
Operating Cost and expenses
Cost of products and services sold 355,000
Selling expenses 155,000
Administrative expenses 45,000
Total Operating cost and expenses 555,000
Income from operations 415,000
Interest expenses (bank loans) 45,000
Legal expenses to start business 28,000
Income Taxes 165,000
Net Income 177,000
To get started, the owner of sound devices spent 100,000 of his personal savings to pay for some of the capital equiptment used in the business. In 2007, the owner of Sound Devices could have earned a 15% return by investing in stocks of other new businesses with risk levels similar to the risk level of Sound Devices.
1) What are the total explicit, total implicit and total economic costs in 2007?
2) What is the accounting profit in 2007?
3) What is the economic profit in 2007?
4) Given your answer in part c , evaluate the owner's decision to leave his job to start sound devices

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