How to Calculate Opportunity Cost with Formula

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). Alternatively, if the business purchases a new machine, it will be able to increase its production of widgets. The machine setup and employee training will be intensive, and the new machine will not be up to maximum efficiency for the first couple of years.

It may sound like overkill to think about opportunity costs every time you want to buy a candy bar or go on vacation. But opportunity costs are everywhere and occur with every decision made, big or small. In this scenario, investing $10,000 in company A returned $2,000, while the same amount invested in company B would have returned a larger $5,000.

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The calculator divides that total by 12 months to adjust your monthly mortgage payment. Average annual premiums usually cost less than 1% of the home price and protect your liability as the property owner and insure against hazards, loss, etc. Your loan program can affect your interest cloud bookkeeping rate and total monthly payments. Choose from 30-year fixed, 15-year fixed, and 5-year ARM loan scenarios in the calculator to see examples of how different loan terms mean different monthly payments. Most home loans require at least 3% of the price of the home as a down payment.

If your loan amount is greater than 80% of the home purchase price, lenders require insurance on their investment. While calculating opportunity cost might seem like a math problem, there is no defined math formula. As we said earlier, opportunity cost is the value of the forgone alternative. Therefore, there is a mathematical way to think of opportunity costs. If you choose to start a business, you’ll have a harder time compared to those who choose to advance their careers. Analyzing such situations will help you understand the concept of opportunity cost and make the best decision without much effort.

Mortgage options and terminology

You accept the offer, sign the contract, and send the first invoice without calculating opportunity cost. Two days later, two separate clients approach you and each offers you a $30,000 monthly fee to handle their respective marketing needs. You can carry out the marketing campaigns for the two smaller clients with your same team of five. In this example, you have sacrificed $10,000 each month because you did not calculate the opportunity cost of taking on the single client for the $50,000 monthly fee. Opportunity cost is different because it’s not always completely obvious.

There are no regulatory bodies that govern public reporting of economic profit or opportunity cost. Companies or analysts can future manipulate accounting profit to arrive at an economic profit. The difference between the calculation of the two is economic profit includes opportunity cost as an expense. This theoretical calculation can then be used to compare the actual profit of the company to what the theoretical profit would have been. Assume that, given $20,000 of available funds, a business must choose between investing funds in securities or using it to purchase new machinery. No matter which option the business chooses, the potential profit that it gives up by not investing in the other option is the opportunity cost.

BMR – Harris-Benedict equation

As an entrepreneur, you should use opportunity costs to make decisions that will positively impact your business and increase returns. Opportunity costs represent the potential benefits that 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.

Mortgage interest is the cost you pay your lender each year to borrow their money, expressed as a percentage rate. The calculator auto-populates the current average interest rate. Opportunities can have similar costs due to emotional or personal reasons. In such instances, having a clear attitude and using the tips that we’ve covered here will help you make the right decisions and boost your productivity.

Opportunity cost example

The problem comes up when you never look at what else you could do with your money or buy things without considering the lost opportunities. Having takeout for lunch occasionally can be a wise decision, especially if it gets you out of the office for a much-needed break. You see that a supplier charges $10 for a certain part—and that’s your cost. Opportunity cost refers to what you miss out on when you choose one option over another.