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# Learning Act 2-8

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Learning activity II ch 8-U4 Exercise 1: Anthony Figueroa is a CPA, who works for an accounting consulting firm. His annual salary income is \$70,000. Anthony is considering opening up his own consulting firm. He estimates that the annual rent for an office would cost him \$20,000; a secretary would cost \$24,000 per year. If he would rent office equipment, he would have to pay \$11,000 per year. The purchase of required supplies, payment of electricity bills, water and telephone bills, would cost approximately ,000 a year.

Anthony estimates that the revenues that he would generate with consulting services would be \$120,000 a year. . Explicit cost = Accounting cost Rent \$20,000 Sal. Secretary 24,000 Off. Equipment 11,000 Utilities 5,000 Total. Ex. Cost\$60,000 b. The forgone salary is \$70,000. c. Economic profit = TR – (Explicit cost + Implicit cost) Economic profit = 120,000 – (60,000+70,000) Economic profit = -10,000 d. Because of the negative result, Anthony should work for someone else, he should not run his own business. Exercise 2: Suppose that the economist of Corporation XYZ estimates the following long run cost function for a product M that the company produces and sells.

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TC = 5Q2 + 10Q +180

The market price for product M is fixed at P = \$70 a. TFC = 180 b. TVC = 5Q? + 10Q c. ATC = MC ATC = TC/Q ATC = (5Q? = 10Q = 180) Q ATC = 5Q +10 +180/Q MC = 10Q + 10 ATC = MC 5Q + 10 +180/Q = 10Q + 10 -5Q + 180Q = 0 Q Q -5Q? + 180 = 0 -5Q? = -180 vQ? =v36 Q = 6 units d. P = MC 70 = 10Q +10 60 = 10Q Q = 6 Profits = TR –TC Profits = 70(6) – (5×6? + 10×6 +180) = 0 Normal profits, because the profits equals 0. P 8-3 Incremental Cost. South Park Software, Inc. produces innovative interior decorating software that it sells to design studios, home furnishing stores, and so on.

The yearly volume of output is 15,000 units. Selling price and costs per unit are as follows: Selling Price \$250 Costs: Direct material \$40 Direct labor 60 Variable overhead 30 Variable selling expenses 25 Fixed selling expenses 20 -\$175 Unit profit before tax \$ 75 Management is evaluating the possibility of using the Internet to sell its software directly to consumers at a price of \$300 per unit. Although no added capital investment is required, additional shipping and handling costs are estimated as follows: Direct labor \$30 per unit Variable overhead 5 per unit Variable selling expenses \$2 per unit Fixed selling expenses \$20,000 per year Calculate the incremental profit that South Park would earn by customizing its instruments and marketing them directly to end users. Incremental revenue per unit (\$300 – \$250) \$50 Incremental variable cost per unit (\$30 + \$5 + \$2) -\$37 Incremental profit contribution per unit \$13 Yearly output volume in unitsH 15,000 Incremental variable profit per year\$195,000 Incremental fixed cost per year -\$20,000 Yearly incremental profit\$175,000

Because the profit is positive, the decision to engage in further processing would be more profitable. P 8. 4 Accounting and Economic Costs. Three graduate business students are considering operating a fruit smoothie stand in the Harbor Springs, Michigan, resort area during their summer break. This is an alternative to summer employment with a local firm, where they would each earn \$6,000 over the three-month summer period. A fully equipped facility can be leased at a cost of \$8,000 for the summer. Additional 0projected costs are \$1,000 for insurance and \$3. 20 per unit for materials and supplies.

Their fruit smoothies would be priced at \$5 per unit. A. What is the accounting cost function for this business? The accounting cost function is: TotalFixed Variable Accounting = TCA = leasing plus + materials plus Cost insurance costs supplies costs = \$8,000 + \$1,000 + \$3. 2Q = \$9,000 + \$3. 2Q B. What is the economic cost function for this business? Economic cost function: Total Economic Summer employment Cost =Opportunity cost+ TCA = 3(\$6,000) + \$9,000 + \$3. 2Q = \$27,000 + \$3. 2Q C. What is the economic breakeven number of units for this operation? Assume a \$5 price and ignore interest costs associated with the timing of lease payments. ) QBE = TFC/P-AVC QBE = \$27,000 5-3. 20 QBE = 15,000 units P8-5 Profit Contribution. Angelica Pickles is manager of a Quick Copy franchise in White Plains, New York. Pickles projects that by reducing copy charges from 54 to 44 each, Quick Copy’s \$600-per-week profit contribution will increase by one-third. A. If average variable costs are 24 per copy, calculate Quick Copy’s projected increase in volume. Before-price reduction: Profit contribution = (P – AVC)Q1 600 = (\$0. 05 – \$0. 02)Q1 Q = 20,000 After the price reduction: Profit Contribution = (P – AVC)Q2 \$800 = (\$0. 04 – \$0. 02)Q2 Q2 = 40,000 Projected increase = Q2 – Q1 = 40,000 – 20,000 = 20,000 copies per week B. What is Pickles’ estimate of the arc price elasticity of demand for copies? Given the large magnitude of this price reduction, use of the arc price elasticity formula is appropriate. EP = Q2 – Q1 x P2 + P1 P2 – P1 Q2 + Q1 EP = 40,000 – 20,000 x \$0. 04 + \$0. 05 \$0. 04 – \$0. 05 40,000 + 20,000 EP = -3 (Elastic) P8-6 Cost-Volume-Profit Analysis.

Textbook publishers evaluate market size, the degree of competition, expected revenues, and costs for each prospective new title. With these data in mind, they estimate the probability that a given book will reach or exceed the breakeven point. If the publisher estimates that a book will not exceed the breakeven point based upon standard assumptions, they may consider cutting production costs by reducing the number of illustrations, doing only light copy editing, using a lower grade of paper, or negotiating with the author to reduce the royalty rate.

To illustrate the process, consider the following data: Cost Category Dollar Amount Fixed Costs Copyediting and other editorial costs \$15,750 Illustrations 32,750 Typesetting 51,500 Total fixed costs\$100,000 Variable Costs Printing, binding and paper \$22. 50 Bookstore discounts 25. 00 Sales staff commissions 8. 25 Author royalties 10. 00 General and administrative costs 26. 25 Total variable costs per copy \$92. 00 List price per copy \$100. 00 Fixed costs of \$100,000 can be estimated quite accurately.

Variable costs are linear and set by contract. List prices are variable, but competition keeps prices within a narrow range. Variable costs for the proposed book are \$92 a copy, and the expected wholesale price is \$100. This means that each copy sold provides the publisher with an \$8 profit contribution. A. Estimate the volume necessary to reach a breakeven level of output. Q = \$100,000 \$8 Q = 12,500 units. B. How many textbooks would have to be sold to generate a profit contribution of \$20,000? Q = Fixed Costs + Profit Requirement

Profit Contribution Q = \$100,000 + \$20,000 \$8 Q = 15,000 units C. Calculate the economic profit contribution or loss resulting from the acceptance of a book club offer to buy 3,000 copies directly from the publisher at a price of \$77 per copy. Should the offer be accepted? Variable cost = \$67 (= \$92 -\$25). Profit contribution per book = \$10 (= \$77 – \$67) \$10 x 3,000 = \$30,000 total profit contribution \$30,000 profit contribution indicates the increase in profits to the publisher from accepting this order, so the offer should be accepted.

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