This opportunity cost calculator calculates the potential benefits you miss by choosing one alternative over another. We are often unable to seize every opportunity that comes our way due to various constraints and circumstances. To achieve something, you have to give up something. That’s why opportunity cost occurred, lets calculate it!
What is Opportunity Cost?
Opportunity cost can be defined in many ways. The simple definition of opportunity cost is, the value of what you give up when you choose one option over another. It’s the benefit you miss out on by not taking the next best alternative.
There are also many types of opportunity costs in various sector besides business and finance, like choice and trade-offs, monetary and non-monetary costs, explicit-implicit costs, etc.
The Formula to Calculate Opportunity Cost
The formula of opportunity cost in finance is straightforward. You just need to subtract the return on the chosen option from the potential return on the best option not chosen.
The formula to calculate opportunity cost is:
Opportunity Cost = Return on Best Option Not Chosen − Return on Chosen Option
Why We Calculate the Opportunity Cost?
We calculate the opportunity cost while choosing a project to make a better decision by understanding the profitability when choosing one alternative over another.
Here’s why calculating opportunity cost is important:
1. Resource Allocation
We can effectively use resources by calculating the opportunity cost. Because resources like time, money, effort, etc are limited. So we need to allocate them for profit maximization.
2. Informed Decision-Making
Comparing the potential benefits of alternatives allows decision-makers to evaluate trade-offs and make informed choices, minimizing regret later.
3. Maximizing Returns
Investors or businesses often face multiple investment or project options. Calculating opportunity cost helps in identifying which choice offers the best return or utility.
4. Risk Management
By understanding what is being sacrificed, businesses and individuals can better assess whether the chosen option is worth the cost or risk. So it could to manage risks with other risk assessment tools.
5. Economic Efficiency
Opportunity cost helps align decisions with goals like profit maximization, cost reduction, or utility maximization, contributing to overall economic efficiency.
Opportunity Cost Example
Example 1:
If you invest $10,000 in Stock A with a 5% return but could have invested in Stock B with an 8% return, the opportunity cost is:
Opportunity Cost = 8% − 5% = 3%
This 3% represents the foregone benefit of not choosing Stock B.
Example 2:
Imagine a company has $100,000 to invest and is choosing between Project A (10% return) and Project B (15% return). If it selects Project A, the opportunity cost is the 5% higher return it could have earned from Project B. This insight can guide future investment decisions.
Final Thoughts
Every financial opportunity is calculable.
In personal finance, if you spend $50 on a meal at a restaurant, the opportunity cost is what you could have done with that $50—like saving it or buying groceries.
In business, a company that uses its factory to produce Product A instead of Product B incurs the opportunity cost of the potential profits it could have earned from Product B.
In time management, choosing to watch TV for an hour instead of exercising means your opportunity cost is the health benefits you could have gained from working out.