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Managerial Economics, Profits and Various Costs Calculations

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1. ABC Corp. owns a piece of land and building a few miles from its headquarters. The land originally cost ABC $500,000 to purchase. ABC is considering using the facility for a new training program. It could also rent a building about the same distance from its headquarters for $20,000 a year. A developer has offered ABC $2.5 million for its property. What factors should ABC consider when deciding whether or not to use its own facility or to sell it and rent the other building? What would you recommend?

2. You have worked as a real estate agent for 10 years and are earning about $100,000 per year with your current agency. You prepared the following information to use in evaluating the financial feasibility of starting your own agency:
Revenues generated during the first year of operations: $1.5 million
Salaries and other labor costs paid to employees during the first year of operations: $1 million
Operating expenses (e.g., rent, communications: $150,000
Equipment purchases: $100,000 with a 5 year straight line depreciation

You need $100,000 in equity, which you can withdraw from your bank account that is currently paying 2% per year in interest, and a $400,000 loan with a 15% interest rate.

a. What is your expected pretax accounting profit from your proposed agency?
b. What is your expected pretax economic profit from your proposed agency?
c. Identify the explicit versus implicit costs.

3. Complete the following table using your understanding of the relationship among the various costs.

0 125 0
10 5.0
20 3.5
30 235
40 130
50 5.5
60 3.0
70 350
80 7.0

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Solution Preview

1. First of all, we should realize that the 500k purchasing cost is a sunk cost (it never comes back regardless of the decision made today), so it should be ignored in the decision making process.

Things to consider

- what is the maintenance cost associated with using the building as a training facility? If the cost is high, it's probably a good idea to sell it a rent a training site instead.

- what is the interest rate? If interest rate is really high, then ABC can sell the building for 2.5mil and invest that money.

I would recommend selling the building because with 2.5mil cash, all ABC has to achieve is a 0.8% return per year to ...