Answer to Question #167941 in Macroeconomics for Martins Anietie

Question

A local restaurateur who had been running a profitable business for many years

recently purchased a three-way liquor license. This license gives the owner the

legal right to sell beer, wine, and spirits in her restaurant. The cost of obtaining

the three-way license was about #90,000, since only 300 such licenses are

issued by the state. While the license is transferable, only #75,000 is refundable

if the owner chooses not to use the license. After selling alcoholic beverages for

about one year, the restaurateur came to the realization that she was losing

dinner customers and that her profitable restaurant was turning into a noisy,

unprofitable bar. Subsequently, she spent about #8,000 placing advertisements

in various newspapers and restaurant magazines across the state offering to sell

the license for #80,000. After a long wait, she finally received one offer to

purchase her license for #77,000. What is your opinion of the restaurateur’s

decisions? Would you recommend that she accept the #77,000 offer? Why?

Answer 1

Solution:

Yes, I would recommend that she accepts the offer of 77,000.

This is because the restaurant owner spent 90,000 in purchasing the Three-way liquor license. However, only 75,000 is refundable if she transfers it. Thus, there is already a loss of 15,000 that the restaurant owner will bear. Given that she had already spent 8,000 on the advertisement, which is a sunk cost, her net loss becomes 23.000.

Given the option of 77,000, the restaurant owner considers that, if she accepts the offer, she would actually be receiving a net amount of 69,000 after deducting 8,000 incurred on the advertisement, resulting in a total loss of 21,000 

Hence the best alternative is the one with minimum loss. In this case, it is to accept the offer of 77,000. Because she was offered 77,000 after a long wait, it is unlikely that she would find the desirous buyer given the current prospects if she declines the offer and waits. Also, she may suffer more losses as she waits for a new offer which will not be prudent as a business person.