Alternatively, if the business purchases a new machine, it will be able to increase its production. Let’s say you value your free time at $200 per hour, and someone offers you a 10-hour job for $2,500. The opportunity cost of taking that job is losing ten hours of your free time. The opportunity cost of not taking the job because you choose to spend time with your family is $2,500. On the other hand, “implicit costs may or may not have been incurred by forgoing a specific action,” says Castaneda.

Under this method, each item is first evaluated separately and then the item values are added together to arrive at a total value for the house. The same approach is used to value used cars, making adjustments to a base value for the presence of options like leather interior, GPS system, iPod dock, and so on. Again, such a valuation approach converts a bundle of disparate attributes into a monetary value. Money that a company which one of these represents an opportunity cost? uses to make payments on its bonds or other debt, for example, cannot be invested for other purposes. So the company must decide if an expansion or other growth opportunity made possible by borrowing would generate greater profits than it could make through outside investments. Let’s say you are deciding to invest in either Company A or Company B. You choose to invest in company A, which provides a return of 6% in one year.

Opportunity Cost and Individual Decisions

Accounting profit is the net income calculation often stipulated by the generally accepted accounting principles (GAAP) used by most companies in the U.S. Under those rules, only explicit, real costs are subtracted from total revenue. Opportunity costs matter to investors because they are constantly selecting the best option among investments.

When building a new aircraft, the materials used may be more useful, so make as many aircraft as possible from as few materials as possible to increase the margin of profit. Any effort to predict opportunity cost must rely heavily on estimates and assumptions. There’s no way of knowing exactly how a different course of action will play out financially over time. Investors might use the historic returns on various types of investments in an attempt to forecast their likely returns. However, as the famous disclaimer goes, “Past performance is no guarantee of future results.”

Opportunity Cost: Definition, Calculation Formula, and Examples

The opportunity cost of spending $19 to download songs from an online music provider is measured by the benefit that you would have received had you used the $19 instead for another purpose. The opportunity cost of a puppy includes not just the purchase price but the food, veterinary bills, carpet cleaning, and time value of training as well. Owning a puppy is a good illustration of opportunity cost, because the purchase price is typically a negligible portion of the total cost of ownership.

Room and board are a cost of an education only insofar as they are expenses that are only incurred in the process of being a student. Similarly, the expenditures on activities that are precluded by being a student—such as hang-gliding lessons, or a trip to Europe—represent savings. However, the value of these activities has been lost while you are busy reading this book. The same process of selecting between payment and action may be employed to monetize opportunity costs in other contexts. For example, a gamble has a certainty equivalent, which is the amount of money that makes one indifferent to choosing the gamble versus the certain payment.

Learn more about this definition and others

The opportunity cost of choosing the guest room option over the gift shop option is $6,900 annually. The opportunity cost of a decision is the benefit that you would have gained if you’d made a different choice. For instance, if you are self-employed, bill $200 per hour, and usually work eight hours, but you decide to take a day off, the opportunity cost of your day off is $1,600. There are intangible and non-quantifiable factors at play in that example. For instance, if you work every day you might face burn-out and actually make less money in the long term.