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Problem

Economic rents True or false?

a. A firm that earns the opportunity cost of capital is earning economic rents.

b. A firm that invests in positive-NPV ventures expects to earn economic rents.

c. Financial managers should try to identify areas where their firms can earn economic rents, because it is there that positive-NPV projects are likely to be found.

d. Economic rent is the equivalent annual cost of operating capital equipment.

Step-by-step solution

(a)

A firm that earns the opportunity cost of capital is earning economic rents. This statement is false.

Economic rent refers to the profits that cover more than the cost of capital. This means that the extra over and above the opportunity cost of capital is known as economic rent. So, a firm only earning opportunity cost of capital will not earn economic rent.

Comment

(b)

A firm that invests in positive–NPV ventures expects to earn economic rents. This statement is true.

Comment

Economic rent refers to the profits that cover more than the cost of capital. A positive NPV earning venture can earn more profits in future. This will lead to extra profit which is termed as economic rents.

Comment

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(c)

Financial managers should try to identify areas where their firms can earn economic rents, because it is there that positive–NPV projects are likely to be found. This statement is true.

Economic rent refers to the profits that cover more than the cost of capital. The venture that can earn economic rents will definitely lead to a positive–NPV situation. The extra profit is the economic rent which is only possible from positive–NPV ventures.

Comment

(d)

Economic rent is the equivalent annual cost of operating capital equipment. This is statement false.

Economic rent refers to the profits that cover more than the cost of capital. Economic rent is not related to cost of operating capital equipment.

Comment

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