James used $250,000 from his savings account that paid an annual interest of 15% to purchase a hardware store. After one year, James sold the business for 320,000. His accountant calculated his profit to be: Sale revenue 320,000 Purchase price 250,000 Total profit: 70,000 James calculates his economic profit to be: Accounting profit 70,000 Implicit cost 37, 500 (250,000 @ 15% for one year) Economic profit 32,500 He recently learned that NPV of a project returns economic profit relative to the best alternative, so he calculates the NPV: PV Year 0 - 250,000 -250,000 Year 1 + 320,000 278,261 = 320,000/1.15 NPV 28,261 Which is different from 32,500 that he obtained using the first method. What is he doing wrong?
James used $250,000 from his savings account that paid an annual interest of 15% to purchase a hardware store. After one year, James sold the business for 320,000. His accountant calculated his profit to be: Sale revenue 320,000 Purchase price 250,000 Total profit: 70,000 James calculates his economic profit to be: Accounting profit 70,000 Implicit cost 37, 500 (250,000 @ 15% for one year) Economic profit 32,500 He recently learned that NPV of a project returns economic profit relative to the best alternative, so he calculates the NPV: PV Year 0 - 250,000 -250,000 Year 1 + 320,000 278,261 = 320,000/1.15 NPV 28,261 Which is different from 32,500 that he obtained using the first method. What is he doing wrong?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Question
James used $250,000 from his savings account that paid an annual interest of 15% to purchase a hardware store. After one year, James sold the business for 320,000. His accountant calculated his profit to be:
Sale revenue 320,000
Purchase price 250,000
Total profit: 70,000
James calculates his economic profit to be:
Accounting profit 70,000
Implicit cost 37, 500 (250,000 @ 15% for one year)
Economic profit 32,500
He recently learned that NPV of a project returns economic profit relative to the best alternative, so he calculates the NPV:
PV
Year 0 - 250,000 -250,000
Year 1 + 320,000 278,261 = 320,000/1.15
NPV 28,261
Which is different from 32,500 that he obtained using the first method. What is he doing wrong?
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