Elinore is asked to invest $5100 in a friend's business with the promise that the friend will repay $5610 in one year. Elinore finds her best alternative to this investment, with similar risk, is one that will pay her $5508 in one year. U.S. securities of similar term offer a rate of return of 7%. What is the opportunity cost of capital in this case?

The opportunity cost of capital is the return or benefit sacrificed in order to take a decision. It is the value of the next benefit sacrifice or forgone in favor of a decision.

Where there exist two or more alternatives, the one with the highest return becomes the opportunity cost.

In the case of Elinore , we compare the return receivable on the the alternative investments, that with the highest return becomes the opportunity cost.

Return on Investment = 5610- 5100 = 510

Return on investment = 510/5100× 100 = 10%

Alternatives:

Alternative 1

Return on investment of similar risk = 5508 - 5100 = 408

408/5100 ×100 = 8%

Alternative 2

Return on US securities = 7%

The alternative 1 promises a return of 8% which is higher than the second alternative , hence the opportunity cost becomes 8%

The opportunity cost = 8%