Firm Firm is an entity which mobilizes resources

Firm: • Firm is an entity which mobilizes resources for production of goods and services to sell in the market • Difference between firm and industry Types of firms: • Sole proprietorship • Partnerships • Corporations

Objectives of Firm Objectives of firm: • Profit maximization or loss minimization

Economic Profit Economic profit = Total revenue – Total economic cost = Total revenue – (Explicit cost + Implicit cost) = Total revenue – Explicit cost – Implicit cost Explicit cost: Cost of market supplied resources (out-of-pocket monetary payments or paid out costs)

Economic Profit Implicit cost: Cost of owner-supplied resources (imputed costs) • Opportunity cost of cash provided to a firm by its owners which accountants refer to as equity capital • Opportunity cost of using land or capital goods owned by the firm • Opportunity cost of the owner's time spent managing the firm or working for the firm in some other capacity

Accounting Profit Accounting profit: Accounting profit = Total revenue – Explicit costs

Practice Question-1 • 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 maintains custom audio equipment for businesses that require high-quality audio systems. A partial income statement for Sound Devices is shown below: • To get started, the owner spent $100, 000 of his personal savings to pay for some of the capital equipment used in the business. In 2014, the owner of Sound Devices could have earned a 15 percent return by investing in the shares of other new businesses with risk level similar to the risk level at Sound Devices. A. What are the total explicit, total implicit and total economic costs in 2014? B. What is accounting profit in 2014? C. What is economic profit in 2014? D. Given your answer in part C, evaluate the owner's decision to leave his job to start Sound Devices. Revenue from sales of product and services Cost of products and services sold Selling/marketing expenses Administrative expenses Interest expense (bank loan) Legal expenses to start business Income taxes 970, 000 355, 000 155, 000 45, 000 28, 000 165, 000

Practice Question-2 • When Burton graduated with from the Canadian Trucking Academy, his father gave him a $350, 000 tractor-trailer rig. Recently, Burton was boasting to some fellow truckers that his revenues were typically $25, 000 per month, while his operating costs (fuel, maintenance, and depreciation) amounted to only $18, 000 per month. Tractor-trailer rigs identical to Burton's rig rent for $15, 000 per month. If Burton was driving trucks for one of the competing trucking firms, he would earn $5, 000 per month. A. How much are Burton's explicit costs per month? How much are his implicit costs per month? B. What is the dollar amount of the opportunity cost of the resources used by Burton each month? C. Burton is proud of the fact that he is generating a net cash flow of $7, 000 (25, 000 – 18, 000) per month, since he would be earning only $5, 000 per month if he was working for a trucking firm. What advice would you give to Burton?

Practice Question-3 • A doctor spent two weeks doing charity medical work in Mexico. In calculating her taxable income for the year, her accountant deducted as businesses expenses her round-trip airline ticket, meals, and a hotel bill for the two-week stay. She was surprised to learn that the accountant, following the taxation rules, could not deduct as a cost of trip the $8, 000 of income she lost by being absent from her medical practice for two weeks. She asked the accountant, "Since lost income is not deductible as an expense, should I ignore it when I make my decision next year to go to Mexico for charity work? " Can you give the doctor some advice on decision making?