Podcast
Questions and Answers
What does accounting profit primarily represent?
What does accounting profit primarily represent?
- The profit gained from investments outside the core business
- The difference between income from sales and incurred costs (correct)
- The overall market value of the firm's equity
- The total revenue generated from all operational activities
Which of the following statements correctly describes a limitation of accounting profit?
Which of the following statements correctly describes a limitation of accounting profit?
- It may not accurately reflect the firm's future earnings potential. (correct)
- It is based solely on cash flow considerations and not on accruals.
- It is always a clear measure of future profitability.
- It incorporates the inherent risks associated with business decisions.
How is economic profit defined in relation to a firm's market value?
How is economic profit defined in relation to a firm's market value?
- The sum of dividends paid out to shareholders during the period
- The accounting profit adjusted for depreciation and amortization
- The total assets minus total liabilities at the end of the period
- The equity market value at the beginning subtracted from that at the end, plus dividends (correct)
What is one advantage of using economic profit over accounting profit?
What is one advantage of using economic profit over accounting profit?
What does the return on equity (ROE) measure?
What does the return on equity (ROE) measure?
What is a feature of bounded rationality in relation to profit maximization?
What is a feature of bounded rationality in relation to profit maximization?
Which financial indicator is commonly used to assess profitability in comparison to accounting profit?
Which financial indicator is commonly used to assess profitability in comparison to accounting profit?
Which of the following is NOT a characteristic of economic profit?
Which of the following is NOT a characteristic of economic profit?
Flashcards
Accounting Profit
Accounting Profit
The difference between a firm's income from sales and its costs (like salaries, machinery, and raw materials).
Profitability
Profitability
A measure of how well a company uses its resources to generate profit, often calculated by comparing accounting profit to invested capital or assets.
Return on Equity (ROE)
Return on Equity (ROE)
The return generated by a company's equity, indicating the profit owners receive for each Euro invested.
Economic Profit
Economic Profit
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Satisfactory Profit
Satisfactory Profit
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Bounded Rationality
Bounded Rationality
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Equity Market Value
Equity Market Value
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Dividends
Dividends
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Study Notes
Accounting Profit
- Definition: Accounting profit is the difference between a firm's revenue and its costs. Calculated over a specific period (usually a year), it considers employee salaries, machinery payments, and material expenses.
- Profitability: Profitability is evaluated by comparing accounting profit to other factors like capital invested (e.g., return on equity). Return on equity measures the profit owners receive for every euro invested.
- Shortcomings: Accounting profit is imprecise, dependent on accounting choices (e.g., depreciation), and overlooks valuable but non-quantifiable assets (e.g., reputation). It primarily reflects past performance, making future prediction difficult. Real-world firms often aim for satisfactory rather than maximum profit, and the concept neglects risk.
Economic Profit
- Definition: Economic profit is the difference between the firm's equity market value at the end of a period and its value at the start, plus any dividends issued during the period.
- Formula: EPt = (EMVt - EMVt-1) + DIVt
- EPt: Economic profit for period t
- EMVt: Equity market value at the end of period t
- EMVt-1: Equity market value at the start of period t
- DIVt: Dividends issued during period t.
- Advantages: Calculated externally by the market, unlike accounting profit. It considers risk and assesses the ability to generate future profit from the firm's equity market value.
Shareholder Profitability/Return
- Definition: Shareholder profitability or return is calculated by dividing economic profit by the investor's initial investment (equity market value).
- Formula: SRt = [(EMVt - EMVt-1) + DIVt] / EMVt-1
- SRt: Shareholder return for period t
- EMVt: Equity market value at the end of period t
- EMVt-1: Equity market value at the start of period t
- DIVt: Dividends issued during period t
- Comparison: Shareholder return is usually compared between similar companies.
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Description
This quiz explores the differences between accounting profit and economic profit, including their definitions, profitability assessments, and inherent shortcomings. Understand how these concepts impact a firm's financial health and decision-making processes.
