Evaluating Performance in a Small Business

Week 2 Homework

3-5: Evaluating Performance in a Small Business

A few years ago, a construction manager earning $70,000 per year working for a regional home builder decided to open his own home building company. He took $100,000 out of one of his investment accounts that had been earning around 6% a year and used that money to start up the business. He worked hard the first year, hiring one employee (his only salary cost for the business was the $40,000 paid to this employee), and generated total sales of $1,000,000. Total material and subcontracted labor costs for the year were $900,000. Calculate accounting profit. What are the opportunity costs for the manager of being in this business relative to returning to his old job? What is the economic profit of the business?

Answer:
Total economic cost = Administrative cost + Opportunity cost of the factors of production

Economic profit = Total revenue - Total economic cost

Opportunity cost of capital = 6% of 100,000 = 6,000

Opporutnity cost of the manager = $70,000

Salary paid to employee = $40,000

Total material and subcontracted labor cost = $900,000

So total economic cost = 6,000 + 70,000 + 40,000 + 900,000

= 1,016,000

Total revenue = $ 1,000,000

So Economic Profit = 1,000,000 – 1,016,000

= -16,000

Thus, he is having an economic loss of $16,000.

5-3: Bagel Company Break-Even Analysis

You are considering opening a bagel restaurant aimed primarily at the breakfast trade. You’ll sell bagels, coffee, and other items in relatively fixed proportions to one another. For each bagel sold, you expect the company to sell two cups of coffee and $2 of other items. You’ll earn $0.50 on each bagel, $0.50 on each cup of coffee, and $1.00 on the other items. Salaries, equipment, and rent cost about $100,000 per year. What is the break-even quantity of bagels?

Answer

Bagel 1 x $ 0.50 = $ 0.50

Coffee 2 x  $ 0.50 =  $ 1.00

Other item 1* x  $ 1.00 = $ 1.00

Total Earnings per combination= $ 0.50 + 1.00 +1.00 = $ 2.50

*let n be the other item number of units

$1: 0.50 = $2 : n ---> 1 x n = 2 x 0.50 ---> n = 1*

Fixed cost = $100,000

Break-even quantity = Fixed cost/ Earning by combo

                                 = 100,000/2.5

                                 =40,000

Bagel @ 1 each combo.

Hence, the bagels break-even quantity is 40,000 units.

...