Last month you lent a work colleague 5000 to cover some over

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 45% the first year. If you let your colleague have another month, what is the opportunity cost of your decision? (Note: Express your answer in dollar and percentage amounts.) The opportunity cost is $ The opportunity cost in percentage is 1%.

Solution

Let\'s assume we are investing the whole $5100 in the oil-well venture with a return of 40% per annum. In that investment, we will get $2040 in a year and 170 in a month. After end of that month, our amount will increase to $5100 + $170 = $5270.

IN this investment option the opportunity cost $170.

Total loss in percentage 3.3%. ($170 is 3.3% of $5100.)

Now, lets take the second option too into account. Here we are getting a return 45%. We are investing the whole amount like before that is $5100. At the end of the year, we would have received a return of $2295 and in a month we would have got $191.25.

So the opportunity cost of not investing is $191.25

The percentage will be 3.75%.