IAI Actuarial Core Principles · Business Economics · Relationship between economics and business
Rohan runs a small advisory firm earning accounting profit of Rs 9 lakh a year. He invested Rs 40 lakh of his own savings in it, which could otherwise earn 8% a year, and he gave up a salaried job paying Rs 7 lakh a year. What is his annual economic profit?
Economic profit is a loss of Rs 1.2 lakh. Implicit costs are forgone interest of Rs 3.2 lakh plus forgone salary of Rs 7 lakh, totalling Rs 10.2 lakh, which exceeds the Rs 9 lakh accounting profit.
- ARs 9 lakh
- BRs 2 lakh
- CRs 1.2 lakh lossCorrect
- DRs 1.8 lakh loss
- Rs 5.8 lakh
Explanation
Implicit costs are forgone interest of 8% of Rs 40 lakh = Rs 3.2 lakh plus forgone salary Rs 7 lakh, total Rs 10.2 lakh. Economic profit = 9 − 10.2 = −Rs 1.2 lakh. Option Rs 2 lakh ignores the interest; Rs 5.8 lakh subtracts only the interest from the profit.
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