Question: 1. You are thinking about becoming a Paradise Coffee franchisee. Franchisees are offered a business specializing in producing an exclusive line of exotic coffee drinks (similar to Starbucks). Franchisees have had good success in towns without a Starbucks (Paradise franchises gross $250,000 sales on average per year). A franchisee pays a fee of $2,000 a year plus 1.5% of gross sales. They also pay an annual National advertising fee of 2% of gross sales. Paradise requires that you use their logo-imprinted goods (plates, cups, napkins) which will cost you $32,000 per year. You also have to use Paradise coffee beans (featuring the exclusive Paradise Roast). You estimate using 375 pounds of beans a year at a cost of $11.00 per pound. Other food ingredients (syrups, muffins, biscotti, whipped cream, soft drinks, etc) will cost $14,000 a year. Other annual expenses are: three workers at a total cost of $60,000; rent $9,600; utilities $4,200; and liability insurance $1,200. You will have to invest $50,000 of your savings (presently earning 5% per annum) and borrow another $60,000 (on which you will pay explicit interest of $3,900 a year). Note: neither the amount of the bank loan nor the $50,000 of your own money you invest is an explicit or implicit cost. However, the interest paid on the bank loan is explicit and the interest foregone on your savings is implicit. You are presently employed as an assistant manager at the VEGGIE Café, earning $45,000 a year (a job you will have to quit to go into Paradise Coffee). However, you believe you are worth $12,000 more than VEGGIE is presently paying you.

a. What is the estimated explicit (accounting) cost of your proposed business? Itemize in detail.

b. What is the accounting profit you project for your business?

c. What is the total implicit cost you estimate for your venture? Itemize in detail.

d. Do you project any economic profit? How much?

e. What is the implied interest rate on your bank loan, based on the above information?

f. From the profit viewpoint, would this be a viable business to start? Explain:

2. Short-Run Cost Puzzle

Use the definitions for TFC, TVC, TC, AFC, AVC, ATC and SMC along with the data provided above to fill in the missing values. Use space below for worksheet.
∞ means infinitely large. Applicable relationships are:

SAC = AFC + AVC
?        ?          ?

- STC/Q = TFC/Q + TVC/Q

- SMC = ΔTVC/ΔQ = ΔTC/ΔQ