Entrepreneurial incentive differs from entrepreneurial profit in that incentive is:
Correct Answer
B) The anticipated reward required to undertake the project
Entrepreneurial incentive concerns the supported anticipated reward for undertaking risk and coordination; entrepreneurial profit is the realized outcome. Observed profit can help estimate incentive, but they are not interchangeable. Contractor fees and construction interest are different cost components.
Why This Is the Correct Answer
Option B is correct because entrepreneurial incentive is the amount an entrepreneur expects to receive from developing a project, the anticipated reward needed to take on its risk and coordination. Entrepreneurial profit, by contrast, is the amount actually received once the project is complete.
Why the Other Options Are Wrong
Option A: The developer's actual realized return after the project sells
Option A, the developer's actual realized return after the project sells, is wrong because that describes entrepreneurial profit, not incentive. Incentive is the expected reward before the outcome is known.
Option C: A fee paid to the general contractor at completion
Option C, a fee paid to the general contractor at completion, is wrong because contractor fees and profit are part of construction costs. They are not the developer's anticipated reward for undertaking the project.
Option D: The interest carried on the construction loan during the build
Option D, the interest carried on the construction loan during the build, is wrong because construction interest is an indirect financing cost. It is a separate cost component, not entrepreneurial incentive.
Incentive before, profit after
Incentive is what the developer expects going in; profit is what the developer actually gets coming out.
How to use: Use this to separate the two terms on definition questions.
Exam Tip
Look for time clues: words like anticipated or expected point to incentive, while realized or actual point to profit.
Common Mistakes to Avoid
- -Treating incentive and profit as the same thing
- -Counting contractor overhead and profit as entrepreneurial incentive
- -Including construction loan interest as part of incentive
Concept Deep Dive
Analysis
This question tests the distinction between entrepreneurial incentive and entrepreneurial profit. Incentive is forward-looking: the reward a developer expects to receive for taking on a project. Profit is backward-looking: the amount actually received after completion, the difference between total development cost and market value.
Background Knowledge
The cost approach recognizes entrepreneurial incentive as an element of cost because developers typically will not build without an expected reward. Observed entrepreneurial profit on past projects can help support an incentive estimate, but the two terms are not interchangeable.
Real-World Application
An appraiser estimating cost new for a proposed subdivision interviews local developers about the margin they need to undertake similar projects. That expected margin supports the entrepreneurial incentive added to cost, separate from contractor fees and loan interest.
More Cost Approach Questions
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Total improvement cost new is $500,000, including short-lived components $70,000 with separately supported loss $30,000. Apply 22% physical loss only to remaining long-lived cost. No other physical loss applies. What total physical depreciation results?
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Correcting a deficiency in the improvements by retrofit would cost $14,000 today and is economically justified. The current cost new of the improvements already includes $9,000, at current prices, for the equivalent item installed during new construction. What amount should be deducted for the deficiency so that the cost is not counted twice?