Opportunity Costs

In much of the project analyses that we have presented in this chapter, we have assumed that the resources needed for a project are newly acquired; this includes not only building and equipment, but also the personnel needed to get the project going. For most

Opportunity Cost: This is the cost assigned to a project resource that is already owned by the firm. It is based upon the next best alternative use.

businesses considering new projects, this is an unrealistic assumption, however, since many of the resources used on these projects are already part of the business and will just be transferred to the new project. When a business uses such resources, there is the potential for an opportunity cost — the cost created for the rest of the business as a consequence of using existing resources in this project instead of elsewhere. This opportunity cost may be a significant portion of the total investment needed on a project.

The opportunity cost for a resource is simplest to estimate when there is a current alternative use for the resource, and we can estimate the cash flows lost by using the resource on the project. It becomes more complicated when the resource has not a current use but potential future uses. In that case, we have to estimate the cash flows foregone on those future uses to estimate the opportunity costs.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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