Opportunity Cost Formula, Calculation, and What It Can Tell You - Deepstash
Opportunity Cost Formula, Calculation, and What It Can Tell You

Opportunity Cost Formula, Calculation, and What It Can Tell You

Curated from: investopedia.com

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What Is Opportunity Cost?

What Is Opportunity Cost?

Opportunity costs represent the potential benefits an individual, investor, or business misses out on when choosing one alternative over another. Because opportunity costs are unseen by definition, they can be easily overlooked.

Understanding the potential missed opportunities when a business or individual chooses one investment over another allows for better decision-making.

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Formula and Calculation of Opportunity Cost

Opportunity Cost = Return on best foregone option (FO) – return on chosen option (CO)

The formula for calculating an opportunity cost is simply the difference between the expected returns of each option. company is faced with the following two mutually exclusive options:

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Opportunity Cost and Risk

The key difference is that risk compares the actual performance of an investment against the projected performance of the same investment, while opportunity cost compares the actual performance of an investment against the actual performance of another investment.

The key difference is that risk compares the actual performance of an investment against the projected performance of the same investment, while opportunity cost compares the actual performance of an investment against the actual performance of another investment.

Still, one could consider opportunity costs when deciding between two risk profiles.

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Economic Profit and Accounting Profit

Opportunity cost is used to calculate different types of company profit.

  • The most common type of profit analysts are familiar with is accounting profit. Accounting profit is the net income calculation often stipulated by Generally Accepted Accounting Principles (GAAP). Only explicit, real costs are subtracted from total revenue.
  • Economic profit (and any other calculation above that considers opportunity cost) is strictly an internal value used for strategic decision-making. There are no regulatory bodies that govern public reporting of economic profit or opportunity cost.

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How Do You Determine Opportunity Cost?

The downside of opportunity cost is it is heavily reliant on estimates and assumptions. There's no way of knowing exactly how a different course of action may have played out financially. Therefore, to determine opportunity cost, a company or investor must project the outcome and forecast the financial impact.

This includes projecting sales numbers, market penetration, customer demographics, manufacturing costs, customer returns, and seasonality.

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IDEAS CURATED BY

ang_

"There's no money in poetry, but then there's no poetry in money, either." ~ Robert Graves

CURATOR'S NOTE

Considering the value of opportunity costs can guide individuals and organizations to more profitable decision-making.

Angela 's ideas are part of this journey:

What Is Opportunity Cost

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The impact of opportunity cost on personal and professional life

Evaluating the benefits and drawbacks of different choices

Understanding the concept of opportunity cost

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