Bob and Jane decide to start their own business selling ergonomically correct furniture that Jane has developed. Suppose they operate this business from leased office space near their house. Also assume that they lease their computer equipment and data base software. The actual production of the furniture is subcontracted to various commercial factories as customer orders arrive and the unassembled kits are shipped via UPS to clients throughout the U.S. Their target market is small businesses including those run out of home offices.
They have so much faith in the potential of Jane's designs that they quit corporate jobs in marketing and MIS administration (which jointly had earned them $250,000 per year), and sink $500,000 (.5 million) of their own funds into this venture at the start of their first year to place advertising in trade journals and on the internet. (Assume this $500,000 had previously been invested in a diversified portfolio that had been averaging a 10% annual before tax rate of return.) At the end of the year they calculated that they had the following costs and revenues.
Total Revenues: $5.0 million
Costs:
Payments to furniture subcontractors $3.5 million
Shipping Costs .1 million
Lease Payments on Office Space and Computer
Equipment &Software $ .1 million
Overhead Expenses: Insurance, utilities etc. $ .1 million
Advertising on Internet & Magazines
(Purchased at start of year) $ .5 million
Additional Sales Expenses (phones,business travel, $ .2 million
Entertaining clients etc.)
Total Listed Costs = $4.5 million
a) Is Bob & Jane's economic profit different from their accounting profit? If so, how much economic profit did they earn during this first year of operation?
b) What were Bob & Jane's fixed costs during their first year of operation ?