In the Context of Capital Budgeting What Is an Opportunity Cost. Give Example
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Capital budgeting is a process which eliminates the most advantageous option for an organisation in generating a profit. The term capital solely means fund that is available for investing and budgeting is its numerical aspects. In whole capital budgeting is concerned with long term investments such as new buildings, new products or new plants all in which requires spending money. Capital budgeting is used mostly by large companies to select among available long- term investments.
The economical term opportunity cost is defined as achieving greater benefits by taking an alternative action. When there is a choice between two outcome, the risk that benefits from outcome might be greater than the another, this is known as opportunity cost.
When a company initiatives a proposed project several resources will be used and these will not be available for other projects. The opportunity cost is the cost of being able to use these resources for other projects. In terms of capital budgeting the most valuable alternative that is given up if a proposed project is undertaken.
Here is an example of opportunity cost in context of capital budgeting. A shareholder has $10,000 worth of stock that they can sell now at the price of $15,000 but instead of selling they decide to wait 4months when the stock was expected to increase. The opportunity cost in this scenario will only be finalized 4 months later, it would be the total difference between $15,000 now and the price they would have earned in then. In this scenario the shareholders decision to sell the stock would depend upon opportunity cost of whether selling the stock 4 months later enables them to make greater profit.