Question

define opportunity costs and explain their role in capital budgeting

Answer 1

Opportunity costs are those costs which are basically the income lost if the particular option is not taken or used. For example a product is produced, if that product is not produced, those labour hours are used to do other work, and contribution is earned from this work, so while calculating the product profit, we consider this lost contribution as the opportunity cost.

Opportunity cost plays a crucial role in capital budgeting, it is important in making a capital structure. As the moeny has alternate uses, and alternate ways to use it. Alternative uses means opportunity cost comes in picture.