When a firm makes a capital acquisition, the implicit cost of capital is:
A)the expense of leasing machines.
B)the expense of buying machines.
C)the opportunity cost of capital.
D)irrelevant for determining economic profit.

Question

Quizplus · Accepted Answer

The implicit cost of capital is the opportunity cost of using the firm's own funds to make a capital acquisition instead of investing them in alternative investments. It represents the rate of return that the firm could have earned on its investment if it had chosen to invest in a different opportunity of equal risk instead. Compared to the explicit cost of capital, the implicit cost is not shown on any accounting records and remains an invisible opportunity cost that presents a real financial liability to the firm. Therefore, it is essential to include the implicit cost of capital in determining economic profit, which accounts for both explicit and implicit costs. The expenses of leasing or buying machines, on the other hand, are explicit costs, which are easily measurable and recorded on financial statements.

When a Firm Makes a Capital Acquisition, the Implicit Cost