Question

What is an opportunity cost rate? How is this rate used in discounted cash flow analysis, and where is it shown on a time line? Is the opportunity rate a single number that is used to evaluate all potential investments?

Answer 1

opportunity cost is the rate of return that an investor could earn had it invested in a alternative project having similar risk,but it did not invest in the project under consideration. so opportunity cost is the costs to a company due to the forgone revenue from investing in an alternative project.

it is the discount rate that is used to calculate the PV of all the future cash flows of the opportunity that we have forgone but could have invested in . this rate must be shown in all the cash flows generated over the tenure of the investment ,if it is not for a single period.

for example the cash flows generated are as follows and the opportunity cost is indicated along every cssh flow in the time line

$50,000/1.04 + $45000/1.04 + $60,000/1.04. so it is shown on all the cash flows generated in the each of the three years the project is evaluated for.

no, it is not a single number.

different investments have different numbers as the opportunity costs/hurdle rate/discount rate.

more riskier investments have a higher rate and less riskier have a lower rate and the projects have a longer maturity will also have a different rate than the projects having a shorter maturity.