Principles of Finance/Section 1/Chapter 2/Time Value of Money/Opportunity Cost

The opportunity cost of capital is the amount of money you forego by investing money in one asset compared to another. For eg. If you have only two alternatives

        a) Invest in an asset which gives 5% return
        b) Invest in another asset which gives 6% return

If you choose the first option, you wont be able to take advantage of the second option. The difference between what you are earning and what you could be earning is the opportunity cost of capital. In this scenario it is 1% (6%-1%). Take another example: say you have a piece of land kept idle. If you make a warehouse over it ,then you cannot use it for any other purpose. So, you miss the earning possibility from any alternative use. That is your opportunity cost.

Last modified on 15 August 2012, at 15:45