Opportunity cost (also known as “alternative cost,”) is the difference between a project’s cost estimate and another option that must be foregone in order to implement the project.
For example, a business owner decides to use $150,000 in retained earnings to expand her warehouse rather than invest it in a new product line. The opportunity cost is the foregone profit the product line might have generated — a trade-off she weighs carefully before committing the capital.
Why it matters: It forces management to allocate capital efficiently; choosing one project means sacrificing the potential returns of another.
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