Opportunity Cost for Project selection



As discussed in other tutorials, at any given moment of time, an organization has multiple ideas waiting to be considered as a project. However, it is practically as well as financially not possible to consider each and every idea as a project and work on it. This does not means that the ideas that are not taken up as a project do not have potential of generating any revenue.

benefit-measurement-methods-of-project-selection

Due to limited resources, it is not practical for you to convert each idea into a project and pursue it. As a result you lose on the capitalizing an opportunity to realize the potential revenue from all such ideas. The revenue that you lose by giving up an idea and converting another idea to a project is known as opportunity cost.

Opportunity cost is just a value and not a benefit. Additionally, you do not add opportunity costs of all candidate projects to arrive at a value. Opportunity cost is just a value of the project you lose for not selecting it. When you consider the opportunity cost of a project, it is always the cost of the value of the next best alternative project and not the cumulative value of all candidate projects.

Therefore, you can also define the opportunity cost as the relative cost because it is a cost of one project relative to the other project.

Calculating an Opportunity Cost

Calculating an opportunity cost for a project, you do not need any special or complicated formula. You just need to calculate the net present value of the projects you are considering and compare the values. You select the project that has a higher net present value. The net present value of the project you do not select is the opportunity cost. To know more about calculating net present value, refer Economic Model for Project Selection – Net Present Value.

Consider a scenario where you have two projects IOS Test App and Android Test App. The net present value for the project IOS Test App is calculated as $ 80,000 and the same for the project Android Test App is calculated as $ 102,000. In this scenario you select the Android Test App project. As a result, the opportunity cost for the Android Test App is $ 80,000. This means that the opportunity cost for selecting the Android Test App project is $ 80,000.

Notice that when calling the opportunity cost, you do not refer to the losing project but the one you have selected, though the value is that of the losing. For example, in the preceding scenario, you have selected the Android Test App project. Therefor, you refer to the opportunity cost of $ 80,000 for the Android Test App and not the IOS Test App project.