Question

Last month, you lent a work colleague $5000 to cover some overdue bills. He agreed to pay you in 1 month with interest at 2% for the month, thus owing you $5100. Today, when the repayment is due, he asked you to extend the loan for another month and he would pay you the $5100 next month. In the meantime, you have had the offer to invest as much as you wish in an oil-well venture that is expected to pay 40% per year and a hot new IT stock that is estimated to return 39% the first year. If you let your colleague have another month, what is the opportunity cost of your decision

Answer 1

The opportunity cost of lending the money to the friend is the largest expected return that could be earned with the money loaned to the friend. From the available opportunity, the investor could earn maximum of 40% by investing in oil well venture. Thus, the opportunity cost to the investor is 40%

The opportunity cost in dollar = Investment * Opportunity cost in %

= $5,000 * 40%

= $2,000

Thus, the opportunity cost in dollar is $2,000