How to Calculate Opportunity Cost

Opportunity cost is defined as what you sacrifice to make another choice. This concept compares what you lose with what you gain based on your decisions. Opportunity costs can be measurable, or can be very difficult to quantify. Understanding the concept of opportunity cost can help you make more informed decisions.

Table of Contents

Calculate opportunity cost

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Identify different options. When faced with two different options, you must calculate the potential benefits that these two options bring. Since you can only choose one of the two options, you will miss out on the benefit of the other. The missed benefit is the opportunity cost. ^{[1] X Research Source}

For example, let’s say your company has $100,000 in side funds, and you have to decide whether to invest in stocks or buy production equipment.
If you decide to invest in a stock, you may gain a profit on that investment, but at the same time you will lose the profit that could have been earned from the purchase of new production equipment.
On the other hand, if you decide to buy new production equipment, you can also benefit from contributing to increased sales, but you will lose the profits earned from investing in stocks.

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Calculate the potential profit of each option. Study each option and estimate the profit that each option brings. For the same example as above, suppose the estimated return of investing in the stock market is 12%. Thus, you can earn 12,000 USD by investing in stocks. On the other hand, let’s say that investing in new production equipment can make you a 10% return, which means you will earn $10,000 by buying fixed assets.

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Choose the best option. Sometimes the best option isn’t the most unprofitable, especially in the short term. Decide which option is best based on long-term goals rather than just potential profits. The company in the above example might choose to invest in new fixed assets instead of investing in the stock market. Because while stock market investing has the potential for higher short-term returns, new production equipment will allow the company to increase efficiency and lower opportunity costs. This will have a lasting effect on the company’s profit margin.

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Calculate opportunity cost. The opportunity cost is the difference in profit between the most attractive option and the chosen one. In the example above, the most attractive option is to invest in stocks, which offer $12,000 in potential profit. The option the company chose, however, was to invest in new production equipment, which brought in $10,000.

Opportunity cost = most attractive option – option chosen.
$12,000 won$ $U$ $S$ $EASY$ $-$ $10,000 won$ $U$ $S$ $EASY$ $=$ $2,000 yen$ $U$ $S$ $EASY$ ${displaystyle 12,000USD-10,000USD=2,000USD}$ $12,000USD-10,000USD=2,000USD$
Thus, the opportunity cost of choosing to buy new equipment is $2,000.

Evaluate business decisions

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Establish capital structure for the business. Capital structure is how much a company pays for its operations and growth. It’s a combination of the company’s debt and equity. Debt can be in the form of a bond issue or a loan from a financial institution. Equity can be in the form of securities or retained earnings. ^{[2] X Research Source}

The company must evaluate the opportunity cost of choosing between debt and equity.
If the company chooses to borrow money to support its growth, the money to pay off the loan principal and interest will no longer be invested in securities.
The company must evaluate the opportunity cost to ensure that the expansion from the borrowed money provides enough returns in the long run to justify forgoing the investment in securities. ^{[3] X Research Sources}

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Evaluate non-financial resources. Opportunity costs are often calculated to evaluate financial decisions. However, many companies can use opportunity costs to coordinate the use of other resources, such as people, time, or manufacturing output. Opportunity cost can be applied to any limited resource within the company. ^{[4] X Research Sources}

Companies have to make decisions about how to allocate resources to different projects. If you spend time on one project, there won’t be time for another.
For example, suppose a furniture company has 450 hours of work per week, and to complete one recliner, it takes the company 10 hours of work, that is, the company will produce 45 pieces per week. The company decided to produce 10 sofas a week, each taking 15 hours to complete. Thus, the company will take 150 hours to produce 10 sofas.
Excluding the time it takes to make the sofa, the company has 300 working hours left, and so can only produce 30 recliners. Therefore, the opportunity cost of 10 sofas is 15 recliners $($ $45$ $-$ $30$ $=$ $15$ $)$ ${displaystyle (45-30=15)}$ $(45-30=15)$ .

Evaluate individual decisions

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Decide whether to hire a maid. Identify which household chores are taking up the most of your time. Consider whether time spent on housework is taking away time spent on more valuable work. Housework like laundry and cleaning can interfere with your work if they take up too much of your time. In addition, time spent on housework can prevent you from engaging in more enjoyable activities, such as taking care of your children or pursuing your own hobbies. ^{[6] X Research Source}

Calculate the financial opportunity cost. Let’s say you work from home and earn $25 per hour. If you hire a maid, you will have to pay 20 USD/hour. The opportunity cost of doing housework yourself is $5/hour $($ $25$ $U$ $S$ $EASY$ $-$ $20$ $U$ $S$ $EASY$ $=$ $5$ $U$ $S$ $EASY$ $)$ ${displaystyle (25USD-20USD=5USD)}$ $(25USD-20USD=5USD)$ .
Calculate the opportunity cost of time. Let’s say you spend 5 hours every Saturday doing laundry, grocery shopping, and cleaning. If you hire a maid to clean and do the laundry once a week, it will only take you 3 hours on a Saturday to complete the laundry and grocery shopping. Now, the opportunity cost of housework is 2 hours.

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Calculate the true cost of going to college. Let’s say you will have to pay $4,000/year to go to college. The government will subsidize an additional $8,000 in tuition fees. However, you must also factor in the opportunity cost of not being able to work while studying. Let’s say you can make $20,000 a year instead of going to college. This means that the real cost of a year of college is tuition plus the opportunity cost of not working. ^{[7] X Research Sources}

The total tuition fee is the amount you have to pay ($4,000) plus the government subsidy ($8,000), which is $12,000.
The opportunity cost of not working is $20,000.
So the opportunity cost of a year of college is $12,000 won$ $U$ $S$ $EASY$ $+$ $20,000 won$ $U$ $S$ $EASY$ $=$ $32,000 won$ $U$ $S$ $EASY$ ${displaystyle 12,000USD+20,000USD=32,000USD}$ $12,000USD+20,000USD=32,000USD$ .
Other opportunity costs associated with going to college include the value of 4 years of real work experience, the value of time spent studying instead of other activities, or the value of things you can afford. buy with the money you pay for tuition or the benefits that money can bring if you invest. ^{[8] X Research Sources}
On the flip side, however, the average weekly income of someone with a college degree will be $400 more than someone with a high school diploma. If you decide not to go to college, the opportunity cost is worth it. income increases in the future. ^{[9] X Trusted Source US Bureau of Labor Statistics Go to source}

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Consider opportunity cost in daily selection. Whenever you make a selection, you will have to ignore the other selection. The opportunity cost is the value of the option you didn’t choose. That value can be personal, financial or environmental. ^{[10] X Research Source}

If you choose to buy a new car over a used car, the opportunity cost is the amount of money you could save if you bought the used car and how you use that difference.
Let’s say you decide to use your tax refund to travel with your family instead of saving or investing. Thus, the opportunity cost is the profit value of the savings or the return on investment.
Remember that value is not necessarily money or tangible property. So when making your decision, you should also consider how your choices will affect your intangible assets, like your happiness, health, and even your free time.

Steps

Calculate opportunity cost

Evaluate business decisions

Evaluate individual decisions

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