Question.2620 - Mr. Ahmad has been working for 5 years at XYZ Co. and is currently employed as a senior software engineer. His current/latest benefit package includes the followings; ? Current monthly (20-day working) gross salary of $20,000. o %50 extra payment if he works on Saturdays. ? One-month (20-day working) paid vacation. ? Full coverage family health insurance, which is financially equal to $30,000. ? One-month gross salary (based on the latest figure) per year completion as indemnity. His current contract offers a yearly salary increase %5 higher than the inflation rate. The country has a personal income tax scheme of $50,000 tax-exempt, if the yearly gross income is between $50,000 and $100,000, and %20 if it is between $100,000 and $250,000, and finally %30 if it is greater than $250,000. Mr. Ahmad thinks that he has enough experience and should do his own business, opening up his own consulting firm. He estimates that he needs $1,000,000 for starting up his business. He has $400,000 on his investment/savings account, which earns yearly %2 higher than inflation rate and he will use his all savings and get 3-year murabaha (loan) of $600,000 from his financial institution to open up his business. He will pay $200,000 principle each year and the current and next year’s pre-determined financing rates are %25, but it will increase to %30, and %40 in the following years respectively according to the contract. According to his employment contract, if he quits his job before completing 10 years, %50 of his indemnity will be cut. Furthermore, if he starts his business, due to the business nature, he will have 6 days weekly work including Saturdays and based on this, his projected revenues during the 3-year period of operation are $1,500,000, $2,000,000, and $3,000,000. On the other hand, his expected expenses for the first year are as follows: ? Monthly total salaries to employed people are $80,000. ? Yearly supplies and equipment expenses are $150,000. ? He has $600,000 rent contract of 3 years, each year of $200,000 for the office. The rent will be fixed for 3 years. ? Monthly total utilities are $5,500. ? One-time license and certification from the government is $25,000. ? The country has a business income tax scheme of no income tax until $100,000. However, it will be between $100,000 and $250,000 and %20 between $250,000 and $500,000, and %30 if it is greater than $500,000. ? Yearly expected inflation rate is %20, 25%, and 30% respectively for the next 3- years. Thus, all expected expenses are projected to increase with inflation rate if not mentioned otherwise. Financial Management CASE STUDY Dr. Talat Ulussever (FIN 501) Spring 2023 GUST Based on then assumptions and projections given above; a) Calculate the explicit cost of each year for three years of opening up his own business. b) Calculate the implicit cost of each year for three years of opening up his own business. c) Calculate the business profit of each year for three years of opening up his own business. d) Calculate the economic profit of each year for three years of opening up his own business. e) Briefly discuss whether Mr. Ahmad should quit his current job and start his own business based on the three-year projection. f) Raise an argument against your answer in e. What might change the answer you gave in e? Briefly discuss.
Answer Below:
a) The explicit cost for each year of opening up his own business for the next three years can be calculated as follows: Year 1: Particular Calculation Amount Remarks Salaries 80,000 * 12 $9,60,000 Supplies and equipment expenses $1,50,000 Rent $2,00,000 Utilities 5,500 * 12 $66,000 License and certification $25,000 Finance Cost 600000*25% $1,50,000 Total $15,51,00 0 Year 2: Particular Calculation Amount Remarks Salaries 80,000 * 12 *(1+ 0.25) $12,00,00 0 (increased by 25% due to inflation) Supplies and Equipment expenses 150,000 * (1 + 0.25) $1,87,500 (increased by 25% due to inflation) Rent $2,00,000 (same as Year 1) Utilities 5,500 * 12 * (1 + 0.25) $82,500 (increased by 25% due to inflation) Finance Cost 400000 * 30% $120000 Income Tax (100000*0) + (110000*10%) $11,000 Total $18,01,00 0 Year 3: Particular Calculation Amount Remarks Salaries 80,000 * 12 (1 + 0.25 + 0.3) $14,88,00 0 (increased by 55% due to inflation) Supplies and equipment expenses 150,000 * (1 + 0.25 + 0.30) $2,43,750 (increased by 55% due to inflation) Rent $2,00,000 (same as Year 1) Utilities 5,500 * 12 * (1 + 0.25 + 0.30) $1,07,250 (increased by 55% due to inflation) Finance cost 200000*40% $80000 Income Tax (100000*0 + 150000*10% + 250000*20% + 381000*30%) $179300 Total $22,98,30 0 b) The implicit cost refers to the opportunity cost of Mr. Ahmad's resources, including his time and capital. In this case, we consider his salary as a senior software engineer at XYZ Co. as the opportunity cost. Year 1 Particular Calculation Amount Salary 30000*12 360000 Insurance 30000 Total 390000 Year 2 Particular Calculation Amount Salary 30000*12*(1+0.25)+30000 480000 Insurance 30000 Total 510000 Year 3 Particular Calculation Amount Salary 30000*12*(1+0.3)+30000 498000 Insurance 30000 Total 528000 c) The business profit of each year for three years of opening up his own business is the revenue minus the explicit cost, which can be calculated as follows: 1) Year 1: $1,500,000 - $1,551,000 = -$51,000 (loss) 2) Year 2: $2,000,000 - $1,801,000 = $199,000 3) Year 3: $3,000,000 - $22,98,300 = $701,700 d) The economic profit of each year for three years of opening up his own business is the revenue minus the explicit and implicit costs 1) Year 1: $1,500,000 - $1,551,000 - $390000 = -$441,000 (loss) 2) Year 2: $2,000,000 - $1,801,000 - $510000 = -$311,000 (loss) 3) Year 3: $3,000,000 - $22,98,300 - $528000 = $173,700 e) Based on the three-year projection, Mr. Ahmad should thoroughly evaluate his decision to leave his current job and start his own business. The first year of operation shows a loss of $51,000, indicating a challenging start. However, the second and third years present a profit of $199,000 and $701,700, respectively, suggesting potential growth and long-term profitability. f) A counterargument against Mr. Ahmad quitting his current job and venturing into his own business revolves around the financial risks involved. Starting a new business necessitates a significant investment, and the initial loss in the first year indicates potential financial hurdles. Furthermore, Mr. Ahmad's current job provides stability, benefits, and a predictable income. Moreover, leaving his job before completing 10 years would result in a reduction in his indemnity. Several factors could potentially alter the answer in e: Market conditions: Changes in the industry, market demand, or competitive landscape could impact the success or failure of the business. Business management: Mr. Ahmad's ability to effectively manage and adapt to challenges in running the business will play a pivotal role in its success. Personal risk tolerance: Mr. Ahmad's willingness to assume risks and his confidence in his entrepreneurial skills may influence his decision. Support network: The presence of mentors, advisors, or a supportive business network can significantly impact the success of a new venture. It is crucial for Mr. Ahmad to carefully assess these factors, evaluate his readiness, skills, and financial stability, and seek professional guidance before making a well-informed decision.More Articles From Finance
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