Opportunity Cost in Finance and Accounting

Opportunity cost in finance and accounting

H. G. Heymann, Robert Bloom 1 Review Quorum Books, 1990 - 199 pages The concept of opportunity cost, an integral part of classical economic theory, is more than two hundred years old. Yet it is still not fully understood today. This work focuses on opportunity cost as it affects decision making, managing, and business problem solving--where the acceptance of one alternative precludes the acceptance of others. H.G. Heymann and Robert

Bloom clarify the issues associated with the opportunity cost principle, the measurement of opportunity costs, and its practical applications in the areas of finance and accounting. By providing numerous examples to demonstrate these specific issues, they make an important, complex economic concept simple to understand. Heymann and Bloom begin their work with simple examples that relate to the opportunity cost principle and introduce the framework in which it has been defined. Following a discussion of basic concepts, applications in economic theory, finance, and accounting are reviewed and analyzed, and increasingly complex, multidimensional, and interdependent problem statements are considered in relation to practical management procedures. The book's interdisciplinary approach addresses a number of issues related to opportunity cost, including the environment in which theories, models, and concepts are developed; the multiple dimensions of problem situations faced by practicing managers; various interpretations of opportunity cost in economic theory; and the relevance of opportunity cost in computer-aided Decision Support Systems. Written in a way that even people with a minimum background in economics can understand, Opportunity Cost in Finance and Accounting will enhance the reader's appreciation of the many complex issues that relate to organizational management, financial decision making, valuation, and opportunity costs. It will be a valuable supplementary text for courses in business and public administration, as well as for developmental seminars for professionals in finance, investment, and accounting. It will also be a significant addition to public, academic, and business libraries.

Opportunity cost is the benefit foregone from not using a good or a resource in its next best alternative use. To value the benefits (outputs) and costs, the opportunity cost measured in economic prices is the appropriate value to be used in project economic analyses. 32. Opportunity Cost of Labor. Assuming that surplus labor is available in the project area, the economic cost of labor employed in a new project will approximate the economic value of net output lost elsewhere, which is reflected in the rural labor wage of casual labor (say 40 taka per day). The labor rate used in the financial analysis of the project is the government controlled minimum wage rate of 60 taka per day. The ratio of the economic opportunity cost of labor to the project wage rate will be 40/60 = 0.67. This means that the true economic cost of labor is two-thirds of the wages paid in

financial prices. 33. Opportunity Cost of Land. The economic value of land in a project is best determined through its opportunity cost. For example, for new projects in a rural area, the opportunity cost of land will typically be the net agricultural output foregone, measured at economic prices. 34. Opportunity Cost of Water. Depending on the source of water, the opportunity cost of water may vary from zero to a very high figure. If the water in the area is abundant, the opportunity cost of using such water is zero; but if, on the contrary, the water is scarce and an urban water supply scheme has to use some water by taking it away from existing agriculture or industrial use, the opportunity cost of water will be equal to the value of net agricultural or industrial production lost by diverting water from these alternative uses. Box 6.2 shows a typical calculation.