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The difference between the value of the decision you did make and the value of the alternative is the opportunity cost. If you decide to invest in a risky stock hoping to realize a high return, you give up the return you might have earned on a bond or blue chip stock.

Businesses must also consider opportunity costs in their decision-making. If a company is considering a capital investment, it must also consider the return it would earn if, instead of going ahead with the capital project, it invested the same amount of money in some other way. In general, a business will only make a capital investment if the opportunity cost is lower than the projected earnings from the new project.

In the same way, if a customer with limited income chooses to buy more of one good or service, he can only do so by forgoing the consumption of other goods or services. The value of the opportunity given up in order to take advantage of the one you decide to take. Because mortgage payments and maintenance costs are usually higher than rent, the new homeowner must also spend more money each month rather than investing it.

BREAKING DOWN 'Opportunity Cost'

On the other hand, the analysis must take into account tax savings because of the deductibility of home mortgage interest payments. Ginnie Mae has an excellent rent versus buy calculator at www.

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Opportunity cost financial definition of opportunity cost https: Opportunity Cost of Capital The difference in return between an investment one makes and another that one chose not to make. This may occur in securities trading or in other decisions. By choosing one alternative, companies lose out on the benefits of the other alternatives.

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  • In other words, opportunity costs are not physical costs at all. They are theoretical costs or missed opportunities. Managers have to evaluate alternative costs in almost every major strategy business decision. For instance, assume a manufacturer needs to increase production and has to decide whether to expand its manufacturing plant or hire a third shift of workers.

    The benefit of expanding the plant would be that the company would have extra capacity and the ability to hire a third shift in the future.

    Opportunity Cost

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