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1.At the beginning of the year, a software developer quit


1.At the beginning of the year, a software developer quit his job and gave up a salary of $90,000 per year in order to start Turnip Tom’s organic farm.  A partial income statement for the first year of operation for Turnip Tom’s, Inc., is shown below:


 $      98,000

Operating costs and expenses

Cost of products sold

 $      15,500

Selling expenses

 $         6,500

Administrative expenses

 $         3,200

Total operating costs

 $      25,200

Income from Operations

 $      72,800

Interest expense (bank loan)

 $         9,500

Legal expenses

 $         1,200

Income taxes

 $      22,000

Net income

 $      40,100

To get started, Tom spent $125,000 of his own savings to purchase land and equipment to be used for the farm.  During this year, Tom could have earned a 7 percent return by investing in stocks of other business with risk levels similar to his farm.

-What are the total explicit, total implicit, and total economic costs for the year?

-What is accounting profit?

-What is economic profit?

– Using only the data given, would you say that the owner made a good economic decision to leave is job to start the organic farm?  Explain.

2. Explain why it would cost Rafael Nadal or Venus Williams more to leave the professional tennis tour and open a tennis shop than it would for the coach of a university tennis team to do so.  Be sure to use the concepts of implicit cost, opportunity cost, and economic cost in your explanation.

3.An article in The Wall Street Journal discusses a trend among some large U.S. corporations to base the compensation of outside members of their boards of directors partly on the performance of the corporation. “This growing practice more closely aligns the director to the company. [Some] companies link certain stock or stock-option grants for directors to improved financial performance, using a measure such as annual return on equity.”

-How would such a linkage tend to reduce the agency problem between managers and shareholders as a whole?

-Why could directors be more efficient than shareholders at improving managerial performance and changing their incentives?

-How does the concept of moral hazard apply to this situation and what policies can be put in place to mitigate it?

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