You are the owner of a firm that operates in a perfectly competitive market.

You are the owner of a firm that operates in a perfectly competitive market. Your accountant has informed you that your firm has earned a profit of $50,000 last year based on his audit of your income statement. Your financial advisor has indicated that the firm’s balance sheet has $2 million worth of debt and your equity is worth $3 million. The cost of debt is 8% and the cost of your equity capital is 10%. Your engineer has informed you that the price of your good is above the average variable cost of production by 7%. Given this information you should

  1. Continue on with production because you are earning an accounting profit.
  2. You should shut down production immediately because your cost of accounting profits are more than economic profits.
  3. You need to change your capital structure to include more equity.
  4. Conclude that you are making an economic loss because your margin over average variable costs is only 7% and this is more than your cost of capital. 
  5. You continue to produce your good, but may want to consider leaving the industry because accounting profits are less than the cost for your equity capital.

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