BUS101: Introduction to Business
Study guide and Definitions
Unit 1: The Context of Business
1.1 Business Basics
Section 4: Profit and Value
Profit is equal to a firm's revenue minus its expenses, while value is the present value of
the firm's current and future profits.
Learning Objective
● Differentiate between profit and value
Key Points
● Normal profit represents the total opportunity costs (both explicit and implicit) of a
venture to an investor, whereas economic profit is the difference between a firm's
total revenue and all costs (including normal profit).
● Given that profit is defined as the difference in total revenue and total cost, a firm
achieves a maximum profit by operating at the point where the difference between
the two is at its greatest.
● The value of a firm is linked to profit maximization. A firm looking to maximize its
profits is actually concerned with maximizing its value.
Term
● Game theory
- A branch of applied mathematics that studies strategic situations in which
individuals or organizations choose various actions in an attempt to maximize
their returns.
Examples
● Which of the following statements is true regarding a firm's value? A) The value of a
firm is the sum of its expected profits; B) The value of a firm is the sum of the PV of
its current and future profits; or C) The value of a firm is its current profit. The
answer is B. The present value of a firm is determined by considering both the
current and expected profits of a firm.
● 1) If a firm's current profits are $10,000 and the firm is expected to earn $10,500 in
profits in each of the next 3 years, What is the value of the firm in present term. The
interest rate is 8%. A) 41,500 B) 39,170 C) 37,060 D) 40,000 The answer is C. The
following equation is used to determine the firm's value: PV(firm)=p(0) + [p(1)/(1+i)]+
[p(2)/(1+i)^2]+ [p(3)/(1+i)^3], where p=10,00 p(1), p(2) and p(3)=10,500, and i=.08.
PV(firm)=10,000+[10,500/(1+.08)]+ [10,500/(1+.08)^2]+ [10,500/(1+.08)^3]
PV(firm)=10,000+9722+9002+8335 PV(firm)=37,060
Study guide and Definitions
Unit 1: The Context of Business
1.1 Business Basics
Section 4: Profit and Value
Profit is equal to a firm's revenue minus its expenses, while value is the present value of
the firm's current and future profits.
Learning Objective
● Differentiate between profit and value
Key Points
● Normal profit represents the total opportunity costs (both explicit and implicit) of a
venture to an investor, whereas economic profit is the difference between a firm's
total revenue and all costs (including normal profit).
● Given that profit is defined as the difference in total revenue and total cost, a firm
achieves a maximum profit by operating at the point where the difference between
the two is at its greatest.
● The value of a firm is linked to profit maximization. A firm looking to maximize its
profits is actually concerned with maximizing its value.
Term
● Game theory
- A branch of applied mathematics that studies strategic situations in which
individuals or organizations choose various actions in an attempt to maximize
their returns.
Examples
● Which of the following statements is true regarding a firm's value? A) The value of a
firm is the sum of its expected profits; B) The value of a firm is the sum of the PV of
its current and future profits; or C) The value of a firm is its current profit. The
answer is B. The present value of a firm is determined by considering both the
current and expected profits of a firm.
● 1) If a firm's current profits are $10,000 and the firm is expected to earn $10,500 in
profits in each of the next 3 years, What is the value of the firm in present term. The
interest rate is 8%. A) 41,500 B) 39,170 C) 37,060 D) 40,000 The answer is C. The
following equation is used to determine the firm's value: PV(firm)=p(0) + [p(1)/(1+i)]+
[p(2)/(1+i)^2]+ [p(3)/(1+i)^3], where p=10,00 p(1), p(2) and p(3)=10,500, and i=.08.
PV(firm)=10,000+[10,500/(1+.08)]+ [10,500/(1+.08)^2]+ [10,500/(1+.08)^3]
PV(firm)=10,000+9722+9002+8335 PV(firm)=37,060
