Question

What is the opportunity cost of a small business investing $1 million in a new project that will pay back $1.5 million in one year? The firm's goal is to end the year with the most assets possible.

Its other alternatives are:
I. Leave $1 million in a bank account and earn $50,000 in interest.
II. Invest $1 million in new equipment that will have a value of $1 million at the end of the year and have earned an additional $100,000 in profits during the year

What is the opportunity cost of the new project?

a. $1,000,000
b. $1,050,000
c. $1,100,000
d. $1,150,000

Answer 1

The opportunity cost of the new project is $1,100,000, because if the firm had chosen the next best alternative, it could have ended the year with the original $1 million plus an additional $100,000 in profit. The correct answer is c. $1,100,000

Step-by-step explanation:

The opportunity cost of a small business investing $1 million in a new project that will pay back $1.5 million in one year is the best alternative forgone, which in this case is the second option - invest $1 million in new equipment that will have a value of $1 million at the end of the year and have earned an additional $100,000 in profits during the year. This is because the firm's goal is to end the year with the most assets possible, and by choosing the new project, the firm forgoes the opportunity to earn an additional $100,000 in profits, which is the highest possible gain from the alternatives presented. Therefore, the correct answer is c. $1,100,000, which represents the sum of the initial $1 million value of the new equipment plus the additional $100,000 in profits that could be earned.