Opportunity cost is what you sacrifice by choosing one over another.What is lost and what is gained are compared based on your decision.It is difficult to quantify an opportunity cost.Understanding the concept of opportunity cost can help you make decisions.
Step 1: Do you have different options?
Determine the potential returns of both options when faced with a choice.You lose the potential returns from the other option if you only choose one option.Your opportunity cost is the loss.If your company has $100,000 in extra funds, you have to decide between investing in securities or buying capital equipment.You can see a return on your investment if you invest in the securities.You can't make a profit from buying new equipment.If you decide to purchase new equipment, you can see a return on that investment in the form of increased sales.You don't get any profit from investing in securities.
Step 2: The potential returns on each option should be calculated.
Estimate the financial return on each option.The expected return on the investment in the stock market is 12 percent.There is a chance of a $12,000 return.The new equipment might increase your profit margin by 10 percent.You could make a $10,000 return on that investment.
Step 3: You can choose the best option.
In the short term, the best option is not the most lucrative.Determine which option is best for you based on your long term goals.The company may invest the funds in new equipment instead of the stock market.The stock market investment has a higher potential return in the short term, but the new equipment will allow them to increase efficiency and lower opportunity costs.Their profit margin will be impacted by this.
Step 4: The opportunity cost can be calculated.
The opportunity cost is the difference between the two options.The securities have a potential return of $12,000 and are the most lucrative option.The company's choice was to invest in new equipment for a return of $10,000.The opportunity cost is the most lucrative option.The cost to purchase new equipment is $2,000.
Step 5: The capital structure of your business should be established.
A company's capital structure is how it funds operations.It is a mix of debt and equity.Debt can be in the form of bonds or loans.Retained earnings can be in the form of stock.When choosing between debt and equity, companies must evaluate opportunity cost.If a company borrows money to fund an expansion, the money used to repay the loan will not be available to be invested into stocks.To justify passing on stock investments, the company must evaluate the opportunity cost to see if the expansion made possible with the debt will generate enough revenue in the long term.
Step 6: Evaluate the non-financial resources.
Opportunity cost can be used to evaluate financial decisions.Companies can use opportunity cost to control their use of other resources, such as man hours, time or mechanical output.Any resource that is limited in the company can be defined as opportunity cost.Companies have to make decisions about how to allocate resources.The time spent on one project is taken away from something else.A furniture company with 450 available man hours per week can produce 45 chairs a week.They decide to make 10 sofas per week.This will take 150 man hours and produce 10 sofas.They have 300 hours left to make 30 chairs.15 chairs are the opportunity cost of the 10 sofas.
Step 7: If you want to be an entrepreneur, you need to know what your time is worth.
Entrepreneurs spend all of their time at their new business.This time could have been used to work at a different job.This is the cost of your opportunity.If you have high earning potential in a different line of work, you must decide if it is worthwhile to open your own business.Suppose you are a chef earning $23 per hour and you decide to leave your job to open your own restaurant.You will spend time buying food, hiring staff, renting the building and opening the restaurant before you ever make a dime from the new business.The opportunity cost is the amount of money you would have made working at your old job during that time.
Step 8: Decide whether or not to hire a maid.
Do you know which household chores are consuming your time?Do you think the time spent on these chores takes away from doing something else that's more valuable?If you work from home a lot, your chores may interfere with your work.If you spend a lot of time on housework, you may not be able to do more enjoyable things, such as being with your children or pursuing a hobby.The financial opportunity cost can be calculated.If you work from home, you will make $25 per hour.You would pay $20 per hour if you hired a maid.The cost to do the housework yourself is $5 per hour.In time, calculate the opportunity cost.You would spend 5 hours each Saturday on laundry, food shopping and cleaning.If a maid came once a week to clean and help with laundry, you would only have to spend 3 hours on Saturday finishing the laundry and food shopping.It takes 2 hours to do the housework yourself.
Step 9: The true cost of going to college can be determined.
If you want to attend an in-state college, you're going to have to pay $4,000 a year.Your tuition will be subsidized by the government.You have to consider the opportunity cost of not working while you are in college.You could make $20,000 a year at a job if you went to college.The opportunity cost of not working and the tuition are the true costs of a year of college.The total tuition is the amount you pay plus the government subsidy, which is a total of $12,000.$20,000 is the opportunity cost of not working.The total cost of a year of college is $12,000+.Four years of real-world work experience, time spent studying instead of other activities, and the value of what you could have purchased with the money you spent on tuition are some of the other opportunity costs associated with going to college.Take into account the other side of the coin.For a person with only a high school degree, median weekly earnings are $400 lower than for someone with a college degree.The opportunity cost is the value of your future earnings if you don't go to college.
Step 10: There are opportunity costs in daily choices.
You are foregoing something when you make a choice.The value of the option you don't choose is the opportunity cost.Something personal, financial, or environmental can be referred to as that value.The opportunity cost is the amount of money you could have saved on a used car if you bought a new car.Suppose you decide to spend your tax return on a family vacation.The opportunity cost is the value of the savings account interest.The value doesn't necessarily mean money or tangible assets.Consider the impact a choice will have on your health, happiness, and free time.