Measuring your opportunity cost

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Definition: Business opportunity means having or becoming capable of utilizing some amount of capital for the benefit of a venture, especially one that involves making money. In more technical terms, it is defined as an entity that performs a service or function that contributes to the public good. (Officially, business opportunity means any trade or profession that contributes to a society. But when most people hear the word opportunity, they imagine something elusive and mysterious.) In other words, opportunity could mean getting rich, being famous, owning your own profitable business, or doing what you love best - whatever it is that you want to do, you can do with an opportunity.

Opportunity cost is "the cost of failing to do something." The opportunity cost of doing something may be called a foregone option. It represents the possible loss of earnings, profit, reputation, time, energy, or resources if you fail to do it. Failure to do something is the foregone option if you have the opportunity.

So, for example, suppose you invest in a new business, which provides you with the opportunity of owning your own business, driving your own cars, working at home, getting paid for your own hours, and saving money on your taxes, right? You get all this without the risk of losing any of these valuable assets. That means opportunity costs are zero. The only thing you lose is the capital investment (what you initially paid for the new equipment). If you lose the investment, you still have the stock market, and you can buy back that stock at a higher price than you paid for it.

But suppose now that the company you invested in has not only failed, but it has gone bankrupt and you have no access to your capital. You have no stock in the company and it is now worth nothing. Opportunity cost is now the sunk cost of the prior investment.

What is the proper way to calculate the opportunity cost of an investment? The best way is called the Sunk Cost Rule. Basically it says that the opportunity cost, or value of an investment does not decrease with time. It goes up as the amount of money that was spent on it increases. So, for example, if you had to pay $1000 upfront for a new business venture, then that would be your sunk cost. You would not want to do that because you will have paid that money back in a much lesser amount of money at some point.

On the other hand, when you look at the Sunk Cost Rule and compare it to the opportunity cost of an investment, you will see that there is a lot of similarity. Your sunk cost is that money you initially put into the investment. Your opportunity cost is the time that it will take to recoup that sunk cost. In many ways, it represents the potential of your new venture.

It also makes sense to add up your entire life's earnings. That includes the money you make at your current job. Now, what are you doing with that money? You are probably investing it in a new business in the hope of gaining more money and increasing your net worth. If you did nothing, then you will have the same amount of wealth as you have today.

In essence, your opportunity cost is your initial investment in your new venture. Think of it as the interest you have to recoup that cost, and then consider how long it will take to recoup that interest. Hopefully, you will have enough time to recoup your investment before your competitors can.