Question

A recent college graduate from Clayton State University has the choice of buying a new car for $33,500 or investing the money for four years with an 11% expected annual rate of return. He has an investment of $41,000 in equities and bonds which yields 8% expected annual rate of return. If the graduate decides to purchase the car, the best estimate of the opportunity cost of that decision is ________.

Question 2 options:

	$3,280
	$18,040
	$14,740
	$41,000

Answer 1

Opportunity Cost :- Opportunity cost is the returns/benefits/profits which has not been earned due to selecting an option from available alternatives. In other words, opportunity cost is the possible earnings that could have been earned if an option has been selected instead of the choosen alternative. E.g. there are two course of action available option A and Option B. Option A will result in net earnings of $ 500 while option B will result in net earnings of $ 600. If we choose option B than opportunity cost is $ 500. Similarly, if we choose option A than opportunity cost is $600. It is pertinent to mention that opportunity cost do not have any effect on financial statements or books of accounts.
In the given problem, the graduate has decided to purchase the Car. The alternative foregone is investment the money for 4 years @11%.
Possible return if the money would have been invested =	Amount to Invest * Annual rate of return * No. of years
						33500*11%*4
						$ 14,740.00
Therefore, the opportunity cost of the decision is $14740.