Think Break #8
• You operate a farm with market value of $700,000 in
land, buildings, machinery, etc. Your debt is
$300,000 with an annual interest payment of
$15,000 this year. Annual revenue averages
$400,000 with operating costs of $320,000. If you
sold the farm, you expect to earn a 5% return if you
invested the money. You think you could work for
the farm co-op in town making $40,000.
• What are the accounting profits you obtain for
owning and operating the farm?
• What are the economic profits you obtain from
owning and operating the farm?
Think Break #8 Answer
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•
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Accounting Profit:
Revenues
Operating Costs
Interest
$400,000
–$320,000
–$15,000
$65,000
• Haven’t dealt with taxes, tax depreciation of
machinery and buildings, etc.
Think Break #8 Answer
•
•
•
•
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Economic Profit:
Revenues
Operating Costs
Interest
Opportunity cost of capital
Opportunity cost of time
$400,000
–$320,000
–$15,000
–$20,000 $700,000–$300,000=
$400,000 at 5%
–$40,000
$5,000
• Stay on the farm: You are beating the “market” by $5,000
• Could separate the $400,000 equity in capital and working
assets ($300,000 land and $100,000 cash) and then use
different opportunity costs (cash @5% and rent at $200/A)