Elinore is asked to invest $5000 in a friend's business with the promise that the friend will repay $5500 in one year's time. Elinore finds her best alternative to this investment, with similar risk, is one that will pay her $5400 in one year's time. Government securities of similar term offer a rate of return of 6%. What is the opportunity cost of capital in this case?

Question

Quizplus · Accepted Answer

The opportunity cost of capital is the return on the best alternative investment. In this case, Elinore's best alternative investment option will give her a return of $5400 in one year's time. Therefore, the opportunity cost of capital is the rate of return on this investment, which is calculated as: 
Opportunity cost of capital = (return on alternative investment / initial investment) x 100%
= (5400/5000) x 100% = 8% 
Since the government securities offer a rate of return of 6%, the best choice for Elinore is to invest in her friend's business as it offers a higher return than the government securities and her best alternative investment.

Elinore Is Asked to Invest $5000 in a Friend's Business