Question

What is opportunity cost and how do opportunity costs figure into cost / benefit analysis?

Answer 1

Opportunity Cost is the micro-economic concept refers to making use of earning profitable source of fund by selecting the suitable choice while neglecting the other choice which have less source of gaining profit. The basic concept of using optimum resources used when the scarcity of choices prevails in the long-run economic equilibrium. All the firms was using the term of opportunity cost in order to avoid the risk for taking the option. Many executive committee teams in the firms makes the research of study on how far the choice of action will fetch the benefits and reduce the risk associated with it. Let us discuss the situation of opportunity cost figuring out in to cost and benefit analysis.

Firms usually use alternative source of pooling the funds to improve their capital structure. The investment for the firms mainly collected from equity and preference share holders. But in order to pay the premium for such share holders, firms chooses the option of investing the fund in the Stocks and Securities. In some instances, due to economic crisis and also due to hyper inflation, the price value or face value of each stocks decreases. It will restrain the future investors to invest in the firms which gives less returns. For example when the investor buy the stock which have face value of 100$. Though the price remains being very less but the decreasing trend of value will urges the negative impact on investors. i.e. For example the value of share being reduced from $100 to $ 25 in two weeks.

But in other side, when the firms choose the another option of investing the funds to buy Treasury Bills of Federal Bank. Though the value of bunch of collective sources of funds of all share holders remains very high when buying the Treasury bills, the safety and the return of purchasing of those Treasury bills will have very high margin. So firms may choose the option of purchasing Treasury bills in order to attract the investors in the long-run. The investors also ensured the safety and high premium. The above facts proves the cost and benefit analysis when choosing the opportunity cost.