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Unformatted text preview: ting a return that provides the
appropriate compensation for bearing the risk of the
When accounting profit is zero, investors would be better off
investing elsewhere because they are not recovering their full
3 Because accounting profit ignores implicit costs,
accounting profit is generally higher than economic
By maximizing economic profit, the financial
manager can maximize shareholder wealth.
Suppose an entrepreneur has $100,000 in cash and
also owns a small building. This individual uses the
cash to start a new venture and the building as a place
During the next year, the business generates
$200,000 in sales revenues and incurs $150,000 in
3 The entrepreneur does not take any salary. Instead of
opening the business, the entrepreneur’s next best
opportunities were to invest the cash elsewhere and
earn $10,000, lease the building for $15,000, and take
a job paying $50,000 for the year. Has this
entrepreneur made a profit?
Solution: The answer depends on the type of profit
under consideration. From an accounting standpoint,
the entrepreneur earned a profit because revenues
exceed costs by $50,000. After factoring in less
obvious costs such as opportunity costs, the
entrepreneur actually experienced an economic loss.
41 Opportunity Costs
The cost of an alternative that must be forgone in
order to pursue a certain action. Put another way, the
benefits you could have received by taking an
The opportunity cost of studying at KIMEP is the
money you would have earned if you worked instead.
On the one hand, you lose four years of salary while
getting your degree; on the other hand, you hope to
earn more during your career, thanks to your
education, to offset the lost wages.
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This note was uploaded on 02/11/2014 for the course FIN 9891 taught by Professor Wu during the Fall '11 term at Kazakhstan Institute of Management, Economics and Strategic Research.
- Fall '11