Chapter 6, Problem 1CQ

Opportunity Cost In the context of capital budgeting, what is an opportunity cost?

Summary Introduction

To define: Opportunity cost.

Opportunity cost:

Opportunity cost means the cost of missed opportunity. It refers to the advantage that a company could have gained, but gave up, to take an alternative action.

Answer to Problem 1CQ

• In the context of capital budgeting, opportunity cost represents the forgone opportunity that a company has lost if the assets of the company have been used in different projects.
• Opportunity cost means the potential revenue from alternative uses that are lost.

Explanation of Solution

Every company’s main motive is to earn maximum return. Company looks for the option that has maximum return. If the company has two alternatives in which company can use its assets to generate revenue, both the alternatives have different risk rates and different returns. Company always wants to choose that action that has greater benefit.

Conclusion

Opportunity cost refers to the forgone cost by taking a course of action.