LU 1:

SCOPE OF MANAGERIAL
ECONOMICS
The Link
 • Relationship to other business disciplines
Managerial Decision
Economics and

Making
 • ABC Express is a company, owns & manages a large fleet of
buses operating in West Malaysia. The managing director, Mr. Ali
has decided to increase the company’s fleet by acquiring another
rival business, the Mesra Express.
Why Managerial

 With the interest rate at 8%, the ABC Express spent

RM9 million to acquire the assets based on
Economics?

predicted additional annual revenues from ticket

sales of RM2 million per year over the first 5 years.
 After the acquisition, Mr. Ali was fired. Why?

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 The Reason

To understand the reasoning, we should refer to the

Net Present Value (NPV)
basic concept of Net Present Value (NPV)

The result show that the NPV is negative – RM

1,014,580

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RECOGNISE TIME VALUE OF MONEY (NET • RM1 today is worth more than RM1 received in the future.

• Reason: opportunity cost of receiving the RM1 in the

future is the forgone interest that could be earned if
RM1 received today.

• E.g. if you invest RM1.00 today at 10% interest rate, 1

year from now RM1.00 would be worth RM1.00 X 1.1
= RM1.10
PRESENT VALUE)
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Formula. The present value (PV) of a future

value (FV) received n years and i interest rate
in the future is
Example NPV

Example: What is the present value of RM100 in 10 years if the

interest rate is at 7 percent?
Example

This means if you invested RM50.83 today at a 7 percent interest

rate in 10 years your investment would be worth RM100.
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The basic idea of the present value can be extended

Example NPV

• Example, if you are promised FV1 one year in the

future, FV2 two years in the future, and so on for n
years, the present value of this sum of future payments
.
is,
to a series of future payments
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QUESTION
Example : Puncak Niaga
A manager of water treatment plants of Puncak
Niaga Sdn Bhd has decided to purchase a new
machine that will cost RM300,000 and has a
useful life of five years. The machine will reduce
NPV in a series of future payments.

cost of operation (year-end) of RM50,000 in year

1, RM60,000 in year 2, RM75,000 in year 3, and
RM90,000 in years 4 and 5.

• What is the present value of the cost savings

of the machine if interest rate is 8 percent?

• Should the manager purchase the machine?

 • Economists are concerned with implicit costs.

• Accordingly, economic costs include not only the

historical costs and explicit costs recorded by the
Economic Profits

accountants, but also the replacement costs and implicit

costs (normal profits) that must be earned on the
owners’ resources.

• Economic profits are total revenue minus all the

economic costs.
Accounting vs Economic Profit
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→ Accounting profit is total amount of money from sales (total

revenue) minus cost of producing goods or services.
→ Accounting cost is measuring cost for financial reporting purposes.
→ Economic profit is the difference between total revenue and total
cost & opportunity cost of producing the firm’s goods or services.
→ Economic cost is measuring costs for decision-making
purposes.
Economic Profit = Total Revenues - Explicit
Costs - Implicit Costs
 Meaning and Measurement of Cost

• There a number of cost concepts in business.

• Opportunity Cost – value of next best
alternative use.
• Explicit vs. Implicit Cost – actual prices
paid vs. opportunity cost of owner-supplied
resources.

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Suppose you own a building in Kuala Lumpur and you

want to run a small restaurant. Food supplies and
labour are your accounting costs. At the end of the
year, your accountant informs you that these costs
were RM50,000 and that your revenues were
RM150,000.
What is your accounting profit?

What is your economic profit? What if you work somewhere else? What if
you rent out your building?
Example:
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QUESTION
Example : ABC Company
A few years ago, a construction manager earning $70,000 per
year working for a regional home builder decided to open his
own home building company, ABC Company. He took $100,000
out of one of his investment account that had been earning 6%
a year and used that money to start up the business. In the first
year, he hired one employee (his salary was $40,000) and
generated total sales of $1,000,000. Total material and
subcontracted labor costs for the year were $90,000.

• Calculate accounting profit

• What is the economic profit for this business?

Credit to Dr Muzahet Masruri

Thank You.