Selling Coffee on Sundays for Adam and Virginia - myassignmenthelp

Question: Discuss about theSelling Coffee on Sundays for Adam and Virginia. Answer: Introduction The given case deals with the business of a coffee shop named as Cartagena which has been opened by Adam and Virginia. The various financial details of the business are provided. In the wake of the same, one of the objectives is to compute the accounting profit and economic profit. Accounting profit refers to the profit which is computed by taking only the explicit costs i.e. the cash outflows which have actually been incurred as a result of the business activity. However, economic profit refers to the profit which takes into consideration not only the explicit costs but also the implicit costs particularly opportunity costs. Further, the above profits need to be determined before and after the penalty cut rates. The penalty rates refer to the higher than normal rates which need to be provided to employees which tend to work on public holidays and weekends. Additionally, sunk cost refers to the cost which has already been incurred and cannot be recovered irrespective of the decision made. Further, another useful concept is the price elasticity of demand which essentially captures the percentage change in quantity demanded when the percentage change is price is one. For elastic goods, the price elasticity is higher while for inelastic goods, the price elasticity is lower. Based on the above concepts, the given business has been analysed to highlight the underlying profit and underlying dynamics particularly related to product demand and average cost. The findings of this are presented as part of this report. Analytical Development The first objective is to compute the accounting and economic profit before and after the penalty rates are cut in accordance with the various costs that have been outlined in the given case. From Table 1 (Appendix 1), it is apparent that accounting profit for each Sunday before the penalty rates are cut amounts to $ 8,100. Further, Table 2 in Appendix 1 highlight that the economic profit before the penalty rate cut is lower at $ 5,800. This is because the opportunity cost associated with loss of salary by Adam and Virginia coupled with loss of rent from shop has also been taken into consideration. Further, in accordance with Table 3, it is apparent that the accounting profit remains the same even when the penalty rates are decreased as the increased savings in employee costs worth $ 1,000 is spent in the form of celebration, thus implying that the profit remains the same. Further, Table 4 highlights the economic profit after decrease of penalty rates and it has increased to $ 6,200 primarily due to lower opportunity cost associated with Adam and Virginia not working at another coffee shop on Sunday. The average cost can be computed by dividing the total expenses with regards to coffee by the number of cups of coffee produced each Sunday. Before, the penalty rates are cuts, the total expense on copy including machine rent, employee cost, other expenditure and cost of selling coffee, the total expense amounts to $ 3,900. Hence, the average cost of coffee comes out as $ 0.975[1]. However, when the penalty rates are cut, there is a decrease in the employee cost by $1,000 and hence the total coffee expense would be reduced to $ 2,900. It is noteworthy that the amount spent on celebration to the tune of $ 1,000 would not be considered as a coffee related expense. Thus, the average cost of coffee comes out as $ 0.725[2] The sunk cost relates to their own salary which they made by working on Sundays. Before the penalty rates are cut, the sunk cost attributed to each of the two partners would be $ 400[3] each assuming 10 hour work shifts. However, after the penalty rates are cut, the sunk cost for each of the partners i.e. Adam and Virginia would get reduced to $ 200[4] each. Based on the information provided in the case, it is known that if the price is increased from the current price of $ 3, the quantity demanded for coffee from that particular case would become zero. As a result, the price elasticity of demand would be (- ) infinity as the sales are extremely sensitive to price. If a particular shop intends to sell it at a price more than $ 3, no customer would buy the same. Clearly, there is no incentive to lower the price and hence the demand elasticity for coffee is (-) infinity indicating. Adam and Virginia are not irrational since if they increase the coffee production, then owing to the increased supply and constant demand there would be a decrease in the market price which would lead to lower prices being charged by the coffee shop. This would not be in the best interest of the business. Conclusion Based on the above discussion, it may be fair to conclude that since the total cost remain the same before and after the cut in penalty rates, hence accounting profit does not alter but the economic profit increases after the penalty rate cut. Further, the business incurs less average cost after the decrease in penalty cost which leads to higher margins. Besides, the demand for coffee in the context of the Cartagena caf is highly elastic which is reflected from the very high magnitude of price elasticity i.e. infinity. Also, it is noteworthy that the decision taken by Adam and Virginia to limit the supply to 4000 cups a day is a rational one as with the increase of supply and lack of commensurate increase of demand to absorb this extra supply, there would be lowering of coffee prices which would not be positive for the coffee business. Also, the difference between the economic and accounting profit has been clearly inferred considering the importance of implied cost (such as opportun ity cost) for the former which ensures that former would never exceed the latter.