Last month, you lent a work colleague $5000 to cover some overdue bills. He agre

Question

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 28% 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 %.

Explanation / Answer

Opportunity cost is the second best alternative forgone.

Since you are giving an extra month for repayment of 5100 which could had invested in IT stock which would have given 45% per year=3.75% per month. Thus opportunity cost=3.75*5100/100=$191.25

Opportunity cost in %=191.25/5100*100=3.75%

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