Chapter 1

Managers, Profits, and Markets

Duplicate Technical Problems

1. For each one of the costs below, explain whether the resource cost is explicit or implicit, and give
the annual opportunity cost for each one. Assume the owner of the business can invest money and
earn 4.5 percent annually.
a. The company’s delivery truck, which cost $150,000 four years ago, is now worth $120,000.
The company has paid off its bank loan used to purchase the truck and now owns the delivery
truck.
b. The janitorial service that keeps the company’s building clean and sanitary charges the
company $2,000 per month, on a month-by-month plan (i.e., no contract is involved). Payment
is made at the end of each month, after the janitorial services have been performed.
c. The company uses a custom-made software program to manage its inventory. The company
paid a consulting firm $32,000 to develop the custom software.
d. A Ricoh color printer and scanner is rented for $3,000 per year. The rental price does not
include the cost of consumables such as toner cartridges and paper.
e. Office secretarial services cost $38 per hour, which includes the cost of providing benefits
(health and dental insurance). The company uses 650 hours of secretarial services annually.

2. During a year of operation, a firm collects $1,200,000 in revenue and spends $865,000 on raw
materials, labor expense, utilities, and rent. The owners of the firm have provided $250,000 of their
own money to the firm instead of investing the money and earning a 9.5 percent annual rate of
return. Treat income tax as an explicit cost of doing business.
a. The explicit costs of the firm are $________. The implicit costs are $________. Total
economic cost is $________.
b. The firm earns economic profit of $________.
c. The firm’s accounting profit is $________.
d. If the owners could earn 15 percent annually on the money they have invested in the firm, the
economic profit of the firm would be ________.

3. Over the next three years, a firm is expected to earn economic profits of $60,000 in the first year,
$50,000 in the second year, and $20,000 in the third year. After the end of the third year, the firm
will go out of business.
a. If the risk-adjusted discount rate is 6 percent for each of the next three years, the value of the
firm is $________. The firm can be sold today for a price of $________.
b. If the risk-adjusted discount rate is 11 percent for each of the next three years, the value of the
firm is $________. The firm can be sold today for a price of $________.

4. Fill in the blanks:

a. Managers will maximize the values of firms by making decisions that maximize ________ in
every single time period, so long as cost and revenue conditions in each period are
_________________.
b. When current output has the effect of decreasing future costs, the level of output that
maximizes the value of the firm will be ________ (smaller, larger) than the level of output that
maximizes profit in a single period.

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 c. When current output has a negative effect on future profit, the level of output that maximizes
the value of the firm will be ________ (smaller, larger) than the level of output that maximizes
profit in the current period.

5. At the beginning of the year, a high school football coach decided to leave his job and give up his
annual coaching salary of $55,000 and open his own sporting goods store. A partial income
statement for follows:

Revenues
Revenue from sales of goods and services................. $210,000
Operating costs and expenses:
Cost of products and services sold............................. $82,000
Selling expenses......................................................... $6,000
Administrative expenses............................................ $12,000
Total operating costs and expenses......................... $100,000
Income from operations................................................. $110,000
Interest expense (bank loan)........................................... $14,000
Non-recurring expenses to start business....................... $24,000
Net income..................................................................... $72,000

To get the sporting goods store opened, the former coach used $60,000 of his personal savings. The
coach opened his store in a building that he owns. Prior to opening his store, the building was
rented for $36,000 per year. The coach could have earned 5 percent return by investing in stocks of
other new businesses with risk levels similar to the risk level associated with his new sporting
goods store.
a. The former high school coach incurs $_______________ of total explicit costs for using
market-supplied resources.
b. The opportunity cost of the owner’s equity capital is $______________ annually.
c. Total implicit cost of owner-supplied resources is $____________.
d. Total economic cost is $_______________, and accounting profit is $_______________.
f. By how much did coach’s wealth change by opening the sporting goods store?

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McGraw-Hill Education.
Answers to Duplicate Technical Problems

1. a. Implicit cost = $5,400 for this year. The owner could sell the delivery truck and invest the
proceeds to earn 4.5 percent annually. Thus, the company’s owners sacrifice $5,400 (= 0.045 
$120,000) in order to use this truck in the business rather than selling the truck and earning
$5,400 in their best alternative investment.
b. Explicit cost = $24,000 per year. The owner must pay the janitorial service each month for a
total annual cost of $24,000. Because the services are paid for at the end of the month after
services have been performed, this cost is not a sunk cost but it is a fixed cost since the monthly
fee is not related to the output of the business.
c. No cost. The custom software cannot be used by any other business, and so it no opportunity
cost.
d. Explicit cost = $3,000 per year. The firm incurs $3,000 per year “out-of-pocket” expense to
obtain the services of the Ricoh color printer/scanner machine itself. The cost of paper and
toner is a separate cost.
e. Explicit cost = $24,700 (= 650  $38) to hire secretarial services.

2. a. $865,000; $23,750; $888,750

b. $311,250
c. $335,000
d. $297,500

3. a. $117,896; $117,896
b. $109,259; $109,259

4. a. profit; independent of decisions in other time periods

b. larger
c. smaller

5. a. $138,000
b. $3,000
c. $94,000
d. $232,000; $72,000
e. –$22,000 (Economic profit = 210,000 – 138,000 – 94,000)

Chapter 1
Copyright ©2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.