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Calculating Opportunity Cost

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calculating-opportunity-cost

We make decisions everyday calculating opportunity cost of one investment compared to another.

Opportunity cost is not a complicated concept but one you need to consider very carefully. For example, you discover that you have just received $25,000 of cash and need to place that in an investment within 5 days.

You start to weigh the options for return on investment (ROI). Do you place your money in a Certificate Deposit (CD) for a 1% return or do you place a down payment on an office building that generates a 12% cash on cash return while the asset appreciates?

These are the type of questions you will ask yourself in business when faced with calculating opportunity cost. Entrepreneurs of startups tend to get upset at Venture Capital firms after being rejected for funding. The VC firms are simply looking at every opportunity presented and weigh the risk vs reward.

Maybe you can loan your $25,000 to a business for 9% interest and it can be secured by a building or vehicles for collateral. In the current economy you can borrow money at around 6.0% for commercial funds from a bank so that’s a pretty good deal. Heck, you could borrow money at 6% and loan it at 9% if you had enough collateral.

In Real Estate investments we tend to pay more for properties with less risk like a GSA lease for 10 years vs a startup that has signed a lease for 5 years.

The take away for calculating opportunity cost is understand the value of any asset based on its’ future cashflows. If you are considering an investment in anything ensure you understand the risk involved in obtaining the future cashflows. If the future cashflows cease to materialize can you regain your principle investment. These type of questions are imperative for discovering the right investment type and class.

Lastly, discover an asset class that you are comfortable with whether it be real estate, stocks, bonds, commodities, startups or a franchise and weigh your opportunity cost very carefully within that asset class.


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