A firm has an average investment of 100,000 during the year. During the same period, the firm has an after-tax income of $16,000. If the cost of capital is 15%, what is the economic profit?
A) +16,000
B) +15,000
C) +1,000
D) None of the above

Question

Quizplus · Accepted Answer

Economic profit is calculated as after-tax income minus the opportunity cost of capital. The opportunity cost of capital is the return the firm could have earned if it had invested the money elsewhere. In this case, the cost of capital is 15%, so the opportunity cost of investing the $100,000 is $15,000. Therefore, the economic profit is $16,000 - $15,000 = $1,000.

A Firm Has an Average Investment of 100,000 During the Year