Opportunity Cost Definition
Revenue that has been forfeited for an alternative use of time or facilities. Often times these types of decisions are made because a company or person forgoes an immediate cash stream for hopefully a larger one in the future.
Opportunity Cost Meaning
Opportunity costs decision making is often based on the potential for higher cash streams in the future. This can happen if a company is developing a new product, and in the meantime has available capacity it could rent out. However, the company keeps it idle in hopes that the new product will develop higher cash flows and use the idle capacity.
Opportunity Cost Examples
Here are some common opportunity costs examples:
– A person who just graduated high school has the chance to take a job at a factory or go to college and gain further knowledge. Often times, the student will go to college because he/she believes that they will be able to make more in the long run over the years by investing in an education.
– A company decides that it needs to invest in new software. It may costs a lot, but if the company becomes more efficient it would be worth it. If the costs to maintain the software is reduced and sales increased it could pay for itself and more in the long run.
– A bank has outstanding loans that have broken covenants. The bank could ask for the full amount right now, but often times they will work with the company so the bank can realize the interest payments along with the principal.
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