Chapter 8 Checking Your Understanding

Chapter 8 Check your Understanding

2) Howard Bowen is a large-scale cotton farmer. The land and machinery he owns has a current market value of $4 million. Bowen owes his local bank $3 million. Last year Bowen sold $5 million worth of cotton. His variable operating costs were $4.5 million; accounting depreciation was $40,000, although the actual decline in value of Bowen’s machinery was $60,000 last year. Bowen paid himself a salary of $50,000, which is not considered part of his variable operating costs. Interest on his bank loan was $400,000. If Bowen worked for another farmer or a local manufacturer, his annual income would be about $30,000. Bowen can invest any funds that would be derived, if the farm were sold, to earn 10 percent annually.(Ignore taxes.)

a. Compute Bowen’s accounting profits.

b. Compute Bowen’s economic profits.

a. Accounting profits:

Revenues $5,000,000

Less: Variable operating costs 4,500,000

Less: Depreciation 40,000

Less: Wages 50,000

Equals: Operating Income $410,000

Less: Interest expense 400,000

Accounting income before tax +$10,000

4) From your knowledge of the relationships among the various cost functions, complete the following table.

Q TC FC VC ATC AFC AVC MC

0 125 125 0 - - - -

10 175 125 50 17.50 12.50 5.00 5.00

20 210 125 85 10.50 6.25 4.25 3.50

30 235 125 110 7.83 4.17 3.67 2.50

40 255 125 130 6.38 3.13 3.25 2.00

50 275 125 150 5.50 2.50 3.00 2.00

60 305 125 180 5.08 2.08 3.00 3.00

70 350 125 225 5.00 1.79 3.21 4.50

80 420 125 295 5.25 1.56 3.69 7.00

6) The Blair Company’s three assembly plants are located in California, Georgia, and New Jersey. Previously, the company purchased a major subassembly, which becomes part of the final product, from an outside firm....