This opportunity cost calculator helps you find the value of the cash you want to spend on a non-investment product. Thanks to this tool, you will be able to calculate how much money you will earn by investing the money instead of spending it on goods or services, and from this find out what the opportunity cost is. Calculating the opportunity cost will also help you decide if the product is worth buying now, as well as learn to use the opportunity cost formula.
Keep reading to find more about the assumptions this tool uses, how to calculate opportunity cost, and the opportunity cost definition. You may also find it useful to go through an opportunity cost example, which provides you with a step-by-step model you can adjust to your own needs.
What is opportunity cost - definition
To answer the question "What is the opportunity cost?", imagine you are deciding between buying two things that you plan to eventually sell. You can only buy one right now. The difference between the future profits is the opportunity cost definition. In this calculator, we specifically compare buying a non-investment good or service with investing the same amount of money at a rate you set.
If you were, let's say, thinking of either buying a new car, or investing the money at a fixed rate, the opportunity cost will be the interest that money accrues while invested (money that could be added to your new car fund). If you are wondering how to calculate opportunity cost, check the sections below to find its formula and some more examples.
How to calculate the opportunity cost
Calculating opportunity cost requires the data mentioned below. Once the calculator has all the necessary data, your results will be instantly presented to you!
- The amount of cash you'd like to spend;
- Your expected rate of return - the rate explains how much will you earn on the investment;
- Years of investment;
- Tax on capital gains - put the current tax rate that you will pay after the investment period; and
- Annual inflation rate - this rate the prices of goods and services increase by.
Follow these steps, and your result will be provided at the bottom of the calculator. If you want to know more, read the following sections to go deeper into its calculation methods, and formulas.
Opportunity cost formula
The opportunity cost formula is a difference between the amount of cash you want to spend now and the cash you will have after the investment term is complete, and therefore finds the profitability of your spending. If you can put off spending that money for a while, and if the interest rate is higher than the inflation rate, you will earn money on it by doing nothing! In the
advanced mode, you can find some more result fields which may help you understand how to calculate opportunity cost:
- Forgone investment earnings - the interest that you will earn on the investment before tax;
- Nominal opportunity cost - the interest from point 1 added to the invested money;
- Tax on capital gains - the amount of tax that you will have to pay due to capital gains; and
- Nominal gains after tax - the value from point 2 after tax has been deducted.
To go deeper into opportunity cost calculation, use the
advanced mode, and follow the formulas below. The bold values are visible only in
Nominal opportunity cost = the money you have * ((1 + rate of return on investment / 12) ^ months of investment - 1)
Tax on capital gains = nominal opportunity cost * income tax rate
Nominal gains after tax = nominal opportunity cost - tax on capital gains
Total savings (after tax) = nominal gains after tax + the money you have
Total gains with inflation = total savings * ((1 - inflation rate / 12) ^ years of investment)
Follow the next section and use those formulas in the example.
Opportunity cost example
Let's go back to thinking about buying a new car. It costs $15,000. Your alternative is to keep using your current vehicle for the next two years, and invest money with a 3 % rate of return. There is a 22 % tax on capital gains, and the inflation rate is 1.5 %. Your interest is compounded monthly - that means your earned interest will be added to your account each month, and next month your interest will be calculated on that new, larger amount. Again, bold values are visible in the
Nominal opportunity cost = $15,000 * (((1 + 3% / 12) ^ 24) - 1) = $926.36
Tax on capital gains = $15,926.36 * 22% = $203.80
Nominal gains after tax = $926.36 - $203.80 = $722,56
Total savings (after tax) = $722,56 + $15,000 = $15,722.56
Total gains with inflation = $15,722.56 * ((1 - 1.5% / 12) ^ 2) = $15,099.94
Based on above opportunity cost example, you may consider two options, buying the car for $15,000 right now, or investing the money using the terms given above and getting $15,722.56 in cash. It's present value - considering inflation would be $15,099.94. Notice how the moneys value changes with time - so you can wait two years and have earned almost $100. All those calculations are possible because of few assumptions, listed in the next section.
Calculating opportunity cost - assumptions
- Interest in this opportunity cost calculator is compounded monthly, the most common measure;
- Inflation and taxes are paid only once and at the end of the investment period;
- Maintenance of goods isn't taken into consideration; and
- Check the opportunity cost definition above to find out more.
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