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
- Continue on with production because you are earning an accounting profit.
- You should shut down production immediately because your cost of accounting profits are more than economic profits.
- You need to change your capital structure to include more equity.
- 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.
- 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.