Put simply, opportunity cost is what a business owner misses out on when selecting one option over another. It’s a way to quantify the benefits and risks of each option, leading to more profitable decision-making overall. Remember that all investing carries risk, and you can lose money in the market.

• Customers are more likely to spend more if they don’t have to pay immediately.
• Review the background of Brex Treasury or its investment professionals on FINRA’s BrokerCheck website.
• Opportunity cost is one of the key concepts in the study of economics and is prevalent throughout various decision-making processes.
• Any way it is calculated or looked at, opportunity cost is still basically the value an individual or entity must forgo when an option is chosen over another potentially viable option.

Kerosene, a product of refining crude, would sell for $55.47 per kilolitre. While the price of kerosene is more attractive than crude, the firm must determine its profitability by considering the incremental costs required to refine crude oil into kerosene. You chose to read this article instead of reading another article, checking your Facebook page, or watching television. Your life is the result of your past decisions, and that, essentially, is the definition of opportunity cost. When you understand opportunity cost, you have the power to measure every alternative with precision and make the right decisions.

How to calculate opportunity cost in business?

The expected return on investment for Company A’s stock is 6% over the next year. It’s in a stable industry environment with no short- or long-term threats. Let’s say you’re trying to decide what to do with $11,000 in retained earnings. You’re thinking of stowing your funds in a business savings account, and there are two standout options. You can also think of opportunity cost as a way to measure a trade-off. Individuals, investors, and business owners face high-stakes trade-offs every day.

Opportunity costs are important to investors because they are always looking for the best investment options. In other words, whenever an investor purchases assets, they tacitly chose to not buy others. This underscores the need to base investment decisions on more than opportunity cost dollar amounts when sizing up options. By using a PPC, business owners can intelligently plan their business models around products that will result in the highest amount of revenue or profit. Keep opportunity cost in mind every time you make a business decision—even a seemingly simple one—and you will give yourself the best chances of succeeding in both the short- and long-term.

The $30 billion initial investment has already been made and will not be altered in either choice. The accounting profit would be to invest the $30 billion to receive $80 billion, hence leading to an accounting profit of $50 billion. However, the economic profit for choosing to extract will be $10 billion because the opportunity cost of not selling the land will be $40 billion.

Scenario #2: Investor dilemma.

NorthOne is proudly made for small businesses, startups, and freelancers. Our platform makes financial management accessible and affordable. We believe that better banking products can make the whole financial system more inclusive. The following examples will help you to further understand what opportunity cost is.

What you sacrifice / What you gain = opportunity costs

If you are wondering how to calculate opportunity cost, check the sections below to find its formula and some more examples. Trade-offs take place in any decision that requires forgoing one option for another. So, if you chose to invest in government bonds over high-risk stocks, there’s a trade-off in the decision that you chose. Opportunity cost attempts to assign a specific figure to that trade-off.

Frequently Asked Questions: Opportunity Cost

Investing in securities products involves risk and you could lose money. Brex Treasury is not a bank nor an investment adviser and your Brex business account is not an FDIC-insured bank account. For example, you purchased $1,000 in new equipment to manufacture backpacks, your number one product.

Once we understand the basics, we can move onto applying the concept to make better business decisions. Review the background of Brex Treasury or its investment professionals on FINRA’s BrokerCheck website. Please visit the Deposit Sweep Program Disclosure Statement for important legal disclosures. Capital structure is the mixture of the debt and equity a company uses to fund its operations and growth. Knowing how to calculate opportunity cost can help you better approach your capital structure. The purely financial opportunity cost of choosing the CD over the CMA is $322.59 in earnings.

Because sunk costs have already happened, the cost will stay the same regardless of a decision’s outcome. Thus, such costs should not be factored into investment decisions. For example, perhaps an investor put capital in Company A but did not realize gains. The money invested is a sunk cost that cannot be recovered, rendering it irrelevant in investment decision-making. In other words, if the investor chooses Company A, they give up the chance to earn a better return under those stock market conditions.

With tax-loss harvesting, you can sell investments that are down to offset realized gains, then reinvest the proceeds in assets aligned to your goals in the current environment. Carefully crafted portfolios generally keep investors from having to consider every investment opportunity, and instead have them consider how much of each asset class an investor should hold. For example, say the parents of an 18-year-old investor advised him to unfailingly put all his disposable income into bonds. Over the next half century, the investor did, in fact, dutifully invest $5,000 annually in bonds, gaining an average yearly return of 2.50 percent. Purchasing the taco on day one and throughout the rest of the month may have been the absolute best decision you could make. Maybe the smoothie wasn’t that good, and maybe you wouldn’t have had a good time if you had gone out for drinks with your friend.

Assessing Personal Decisions

While the data and analysis Stash uses from third party sources is believed to be reliable, Stash does not guarantee the accuracy of such information. Nothing in this article should be considered as a solicitation or offer, or recommendation, rent invoice template to buy or sell any particular security or investment product or to engage in any investment strategy. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.