Deck 21: Rents, Profits, and the Financial Environment of Business

Question 1

Why Many Older People Are Planning to Work More Years
Scott Ghelfi, a businessman in his early 50s in Massachusetts, is rethinking his retirement plan. When Ghelfi originally formulated that plan more than a decade ago, he had thought he would accumulate sufficient retirement savings to allow retirement by no later than age 65. Now he is very doubtful that will happen. The problem is that Ghelfi's retirement savings are not growing as fast as he had anticipated. One reason for the slower savings growth is that Ghelfi's business has earned fewer profits in recent years, which has resulted in an unexpected reduction in his annual flow of retirement saving. Another reason is that interest rates have been very low. Consequently, the annual interest receipts added to his alreadyaccumulated retirement savings are much lower than he had anticipated.
Ghelfi is among many older U.S. residents confronting the fact that the amount of accumulated savings available to them at their desired retirement age will surely be lower than they thought. A number of these workers are concluding that the best option for aligning their retirement plans with the realities they face is to push back their scheduled retirement dates. Consequently, Ghelfi and millions of other older U.S. residents are opting to keep working-and saving-for several more years than they had originally intended.
Why do low interest rates mean that a lower-than-intended present value of retirement savings translates into a smaller-than-expected future value?

Answer 1

Due to lower interest rates for almost half a decade and unexpected reduction in the annual flows, individuals are facing a lower value of their intended savings. This has forced them to work for few more years than what they have planned for. A lower interest rate implies that the present value of retirement earnings is more now than for a higher one.
This ultimately implies a lower future value than the expected one because the discounting factor is high. If interest rate is increased, the present value will fall and discounting factor will increase. This will increase the future value of earnings.

Question 2

Government Agencies Are a Treasure Trove of Information
The Federal Reserve and other government agencies have been tightening the systems through which they hold back or release information. The Federal Reserve and agencies such as the Census Bureau and the Bureau of Economic Analysis tabulate information about the entire economy. Many people make market decisions based on movements in economic data, so anyone who obtains these agencies' data earlier than others potentially could profit. Consequently, these agencies seek to ensure that such data are released to everyone at the same instant.
Other agencies, such as the Federal Communications Commission and the Securities and Exchange Commission, are privy to flows of confidential information about specific firms. Knowledge of such information might enable someone to earn insider-trading profits from trading these firms' stocks. Thus, the agencies strive to protect these data from being released to anyone else.
An "Open Government" That Is Open to Only a Few at a Time?
In some cases, government releases of profitable information may be required by law. Under the 1967 Freedom of Information Act (FOIA), anyone can request information from a federal agency. In most instances, the agency must provide the information.
Recent reviews of FOIA requests have revealed that tens of thousands of such requests likely were associated with efforts to obtain profitable information. Government critics have suggested two possible ways to reduce the scope of this problem. One would be for the government to respond to an FOIA request by releasing information to the general public instead of only the requesting party. The other would be for the government to reduce its involvement in private markets and consequently collect fewer data that could be transformed into insider information via FOIA requests.
Why could insider information released by government agencies sometimes be as profitable as insider information illegally obtained from private firms?

Answer 2

Question 3

Which of the following individuals would you expect to have a high level of economic rent, and which would you expect to have a low level of economic rent? Explain why for each. a. Bob has a highly specialized medical skill shared by very few individuals.
B) Sally has never attended school. She iS₂5 years old and is an internationally known supermodel.
C) Tim is a high school teacher and sells insurance part time.

Answer 3

(A) Specialized medical skills lead to a higher economic rent. This is because Bob possess a specialized skill and there are only few substitutes which exists in the market for the specialized skill. Thus, Bob earns a high economic rent as the supply of the specialized medical skill is inelastic in its nature and the Bob's skill demand is high in the market.
(b) Sally earns a high economic rent because she is an internationally known super model. Though Sally is not educated she earns high income due to popularity.
(c) Tim's earns a low economic rent. This is because his opportunity cost of working part-time is low. And his wage earned is most likely to equal to his opportunity cost.

Question 4

Why Many Older People Are Planning to Work More Years
Scott Ghelfi, a businessman in his early 50s in Massachusetts, is rethinking his retirement plan. When Ghelfi originally formulated that plan more than a decade ago, he had thought he would accumulate sufficient retirement savings to allow retirement by no later than age 65. Now he is very doubtful that will happen. The problem is that Ghelfi's retirement savings are not growing as fast as he had anticipated. One reason for the slower savings growth is that Ghelfi's business has earned fewer profits in recent years, which has resulted in an unexpected reduction in his annual flow of retirement saving. Another reason is that interest rates have been very low. Consequently, the annual interest receipts added to his alreadyaccumulated retirement savings are much lower than he had anticipated.
Ghelfi is among many older U.S. residents confronting the fact that the amount of accumulated savings available to them at their desired retirement age will surely be lower than they thought. A number of these workers are concluding that the best option for aligning their retirement plans with the realities they face is to push back their scheduled retirement dates. Consequently, Ghelfi and millions of other older U.S. residents are opting to keep working-and saving-for several more years than they had originally intended.
If interest rates rise, could Ghelfi again consider retiring earlier? Explain.

Question 5

Government Agencies Are a Treasure Trove of Information
The Federal Reserve and other government agencies have been tightening the systems through which they hold back or release information. The Federal Reserve and agencies such as the Census Bureau and the Bureau of Economic Analysis tabulate information about the entire economy. Many people make market decisions based on movements in economic data, so anyone who obtains these agencies' data earlier than others potentially could profit. Consequently, these agencies seek to ensure that such data are released to everyone at the same instant.
Other agencies, such as the Federal Communications Commission and the Securities and Exchange Commission, are privy to flows of confidential information about specific firms. Knowledge of such information might enable someone to earn insider-trading profits from trading these firms' stocks. Thus, the agencies strive to protect these data from being released to anyone else.
An "Open Government" That Is Open to Only a Few at a Time?
In some cases, government releases of profitable information may be required by law. Under the 1967 Freedom of Information Act (FOIA), anyone can request information from a federal agency. In most instances, the agency must provide the information.
Recent reviews of FOIA requests have revealed that tens of thousands of such requests likely were associated with efforts to obtain profitable information. Government critics have suggested two possible ways to reduce the scope of this problem. One would be for the government to respond to an FOIA request by releasing information to the general public instead of only the requesting party. The other would be for the government to reduce its involvement in private markets and consequently collect fewer data that could be transformed into insider information via FOIA requests.
How would full public release of information in response to an FOIA request help to prevent the requesting party from being able to profit from the information?

Question 6

Which of the following individuals would you expect to have a high level of economic rent, and which would you expect to have a low level of economic rent? Explain why for each. a. Emily quit high school at age 17, and she has since worked for several years as a waitress in fast-food restaurants.
B) Demetrius earned a Ph.D. in financial economics, and he is among a handful of experts who specialize in assessing the values of highly complex securities traded in bond markets.
C) Xin was a child prodigy on the violin, and after years of developing her skills, she is now rated among the most talented performing violinists in the world.

Question 7

In which of the following situation(s) will owners who supply factors of production be most likely to earn economic rents? a. Highly elastic supply of the factor; highly elastic demand for the factor
B) Highly elastic supply of the factor; highly inelastic demand for the factor
C) Highly inelastic supply of the factor; highly inelastic demand for the factor

Question 8

A British pharmaceutical company spent several years and considerable funds on the development of a treatment for HIV patients. Now, with the protection afforded by patent rights, the company has the potential to reap enormous gains. The government, in response, has threatened to tax away any economic rents the company may earn. Is this an advisable policy? Why or why not?

Question 9

Write a brief explanation of the differences among a sole proprietorship, a partnership, and a corporation. In addition, list one advantage and one disad- vantage of a proprietorship, a partnership, and a corporation.

Question 10

After graduation, you face a choice. One option is to work for a multinational consulting firm and earn a starting salary (benefits included) of $40,000. The other option is to use $5,000 in savings to start your own consulting firm. You could earn an interest return of 5 percent on your savings. You choose to start your own consulting firm. At the end of the first year, you add up all of your expenses and revenues. Your total includes $12,000 in rent, $1,000 in office supplies, $20,000 for office staff, and $4,000 in telecommunications expenses. What are your total explicit costs and total implicit costs?

Question 11

Suppose, as in Problem 21-6, that you have now operated your consulting firm for a year. At the end of the first year, your total revenues are $77,250. Based on the information in Problem 21-6, what is the accounting profit, and what is your economic profit?
REF PRB:
After graduation, you face a choice. One option is to work for a multinational consulting firm and earn a starting salary (benefits included) of $40,000. The other option is to use $5,000 in savings to start your own consulting firm. You could earn an interest return of 5 percent on your savings. You choose to start your own consulting firm. At the end of the first year, you add up all of your expenses and revenues. Your total includes $12,000 in rent, $1,000 in office supplies, $20,000 for office staff, and $4,000 in telecommunications expenses. What are your total explicit costs and total implicit costs?

Question 12

An individual leaves a college faculty, where she was earning $80,000 a year, to begin a new venture. She invests her savings of $20,000, which were earning 10 percent annually. She then spends $40,000 renting office equipment, hires two students at $60,000 a year each, rents office space for $24,000, and has other variable expenses of $80,000. At the end of the year, her revenues are $400,000. What are her accounting profit and her economic profit for the year?

Question 13

Classify the following items as either financial capital or physical capital. a. A computer server owned by an informationprocessing company
B) $100,000 set aside in an account to purchase a computer server
C) Funds raised through a bond offer to expand plant and equipment
D) A warehouse owned by a shipping company

Question 14

Explain the difference between the dividends of a corporation and the profits of a proprietorship or partnership, particularly in their tax treatment.

Question 15

The owner of WebCity is trying to decide whether to remain a proprietorship or to incorporate. Suppose that the corporate tax rate on profits iS₂0 percent and the personal income tax rate is 30 percent. For simplicity, assume that all corporate profits (after corporate taxes are paid) are distributed as dividends in the year they are earned and that such dividends are subject to tax at the personal income tax rate.
a. If the owner of WebCity expects to earn $100,000 in before-tax profits this year, regardless of whether the firm is a proprietorship or a corporation, which method of organization should be chosen?
b. What is the dollar value of the after-tax advantage of the form of organization determined in part (a)?
c. Suppose that the corporate form of organization has cost advantages that will raise beforetax profits by $50,000. Should the owner of WebCity incorporate?
d. Based on parts (a) and (c), by how much will after-tax profits change due to incorporation?
e. Suppose that tax policy is changed to completely exempt from personal taxation the first $40,000 per year in dividends. Would this change in policy affect the decision made in part (a)?
f. How can you explain the fact that even though corporate profits are subject to double taxation, most business in the United States is conducted by corporations rather than by proprietorships or partnerships?

Question 16

Explain how the following events would likely affect the relevant interest rate.
b. The government has passed legislation requiring bank regulators to significantly increase the paperwork required when a bank makes a loan.

Question 17

Suppose that the interest rate in Japan is onlY ₂ percent, while the comparable rate in the United States is 4 percent. Japan's rate of inflation is 0.5 percent, while the U.S. inflation rate is 3 percent. Which economy has the higher real interest rate?

Question 18

You expect to receive a payment of $104 one year from now.
a. Your rate of discount is 4 percent. What is the present value of the payment to be received?
b. Suppose that your rate of discount rises to 5 percent. What is the present value of the payment to be received?

Question 19

Outline the differences between common stock and preferred stock.

Question 20

Explain the basic differences between a share of stock and a bond.

Question 21

Suppose that one of your classmates informs you that he has developed a method of forecasting stock market returns based on past trends. With a monetary investment from you, he claims that the two of you could profit handsomely from this forecasting method. How should you respond to your classmate?

Question 22

Suppose that you are trying to decide whether to spend $1,000 on stocks issued by WildWeb or on bonds issued by the same company. There is a 50 percent chance that the value of the stock will rise to $2,200 at the end of the year and a 50 percent chance that the stock will be worthless at the end of the year. The bonds promise an interest rate of 20 percent per year, and it is certain that the bonds and interest will be repaid at the end of the year.
a. Assuming that your time horizon is exactly one year, will you choose the stocks or the bonds?
b. By how much is your expected end-of-year wealth reduced if you make the wrong choice?
c. Suppose the odds of success improve for WildWeb: Now there is a 60 percent chance that the value of the stock will be $2,200 at year's end and only a 40 percent chance that it will be worthless. Should you now choose the stocks or the bonds?
d. By how much did your expected end-of-year wealth rise as a result of the improved outlook for WildWeb?