The following information is available for Rory Company: Invested capital is defined as total assets.Before-tax operating profit is $175,000.After-tax operating profit is $125,000.The after-tax cost of capital is 10%.What is economic profit?
A)$95,000
B)$125,000
C)$145,000
D)$175,000

Question

The following information is available for Rory Company:  Invested capital is defined as total assets.Before-tax operating profit is $175,000.After-tax operating profit is $125,000.The after-tax cost of capital is 10%.What is economic profit?
A)$95,000 
B)$125,000 
C)$145,000 
D)$175,000

Quizplus · Accepted Answer

Economic profit is calculated as after-tax operating profit minus the cost of capital multiplied by the invested capital.

Economic profit = After-tax operating profit - (Cost of capital x Invested capital)
Economic profit = $125,000 - (0.1 x Total assets)

We don't have the information about the value of total assets but it can be assumed to be the invested capital. So, economic profit = $125,000 - (0.1 x Invested capital)

Since the cost of capital is 10%, the economic profit will be positive only if the after-tax operating profit is greater than 10% of the invested capital. As we don't know the exact value of invested capital, we cannot calculate the economic profit directly. However, we know that the after-tax operating profit is $125,000, which is greater than 10% of any amount of invested capital (since 10% of any amount would be less than $125,000). Therefore, economic profit must be positive and the best choice is A.

The Following Information Is Available for Rory Company: Invested