ME - Tutorial 4
1. Andrew operates a small shop specializing in
party favors. He owns the building and supplies
all his own labor and money capital. Thus,
Andrew incurs no explicit rental or wage costs.
Before starting his own business Andrew earned
$1,000 per month by renting out the store and
earned $2,500 per month as a store manager for a
large department store chain. Because Andrew
uses his own money capital, he also sacrificed
$1,000 per month in interest earned on U.S.
Treasury bonds. Andrews monthly revenues
from operating his shop are $10,000 and his total
monthly expenses for labor and supplies
amounted to $6,000. Calculate Andrews monthly
accounting and economic profits.
2. The sole proprietor of the "Books and More"
bookstore receives all accounting profits earned
by her firm and a $28,000-a-year salary she pays
herself. She has a standing salary offer of
$35,000 a year if she agrees to work for a large
corporation. If she had invested her capital
outside her own company, she estimates that
would have returned $22,000 a year. Last year,
her accounting profit was $50,000. What was her
economic profit?
3. Assume a 10% discount rate. Compute the
present value of Rs. 1100, Rs. 900, Rs 1500, and
Rs. 700 at the end of one through four years.
4. Sadhulal Bhai is borrowing Rs 50,000 to buy a
low-income group house. If he pays equal
installments for 25 years and 4 percent interest
on outstanding balance, what is the amount of
installment? What shall be amount of installment
if quarterly payments are required to be made?
5. Exactly ten years from now Sri Chand will start a
receiving a pension of Rs. 3000 a year. The
payment will continue for sixteen years. How
much is the pension worth now if Sri Chand
interest rate is 10%?
6. You have been hired as a financial advisor to
Michael Jordan. He has received two offers for
playing professional basketball and wants to
select the best offer, based on considerations of
money only. Offer A is a $10m offer for $2m a
year for 5 years. Offer B is a $11m offer of $1m a
year for four years and $7m in year 5. What is
your advice?
ME - Tutorial 4
1. Andrew operates a small shop specializing in
party favors. He owns the building and supplies
all his own labor and money capital. Thus,
Andrew incurs no explicit rental or wage costs.
Before starting his own business Andrew earned
$1,000 per month by renting out the store and
earned $2,500 per month as a store manager for a
large department store chain. Because Andrew
uses his own money capital, he also sacrificed
$1,000 per month in interest earned on U.S.
Treasury bonds. Andrews monthly revenues
from operating his shop are $10,000 and his total
monthly expenses for labor and supplies
amounted to $6,000. Calculate Andrews monthly
accounting and economic profits.
2. The sole proprietor of the "Books and More"
bookstore receives all accounting profits earned
by her firm and a $28,000-a-year salary she pays
herself. She has a standing salary offer of
$35,000 a year if she agrees to work for a large
corporation. If she had invested her capital
outside her own company, she estimates that
would have returned $22,000 a year. Last year,
her accounting profit was $50,000. What was her
economic profit?
3. Assume a 10% discount rate. Compute the
present value of Rs. 1100, Rs. 900, Rs 1500, and
Rs. 700 at the end of one through four years.
4. Sadhulal Bhai is borrowing Rs 50,000 to buy a
low-income group house. If he pays equal
installments for 25 years and 4 percent interest
on outstanding balance, what is the amount of
installment? What shall be amount of installment
if quarterly payments are required to be made?
5. Exactly ten years from now Sri Chand will start a
receiving a pension of Rs. 3000 a year. The
payment will continue for sixteen years. How
much is the pension worth now if Sri Chand
interest rate is 10%?
6. You have been hired as a financial advisor to
Michael Jordan. He has received two offers for
playing professional basketball and wants to
select the best offer, based on considerations of
money only. Offer A is a $10m offer for $2m a
year for 5 years. Offer B is a $11m offer of $1m a
year for four years and $7m in year 5. What is
your advice?
 Solutions

Solution 1 Accounting Profit = 10000 6000 = 4000

Opportunity Cost = 1000+2500+1000 = 4500
Economic Profit = 4000 4500 = -500

Solution 2 In order to calculate her economic profit, we need to subtract her implicit costs from the accounting
profit. By not taking an alternative job, she loses $7,000 ($35,000 - $28,000). This is the opportunity cost of her
time. The opportunity cost of keeping her capital tied up in her company is $22,000. The economic profit is
therefore $50,000 - $7,000 - $22,000 = $21,000.

Solution 3 PV = 1100/(1+10%) + 900/(1+10%)^2 + 1500/(1+10%)^3 + 700/(1+10%)^4 = 3349

Solution 4

Solution 5
PV of 16 annuity payments at the end of 9th year = 3000*[{1-(1+10%)^-16}/10%] = 23471
PV of 9th year payment today = 23471 / (1+10%)^9 = 9954

Solution 6