Opportunity cost formula: calculation, examples, and best practices

You have $100,000 set aside for growth, but where should you put it? Expanding into new markets might generate more revenue, but hiring a marketing manager could lead to more sales. Then again, upgrading some of your legacy systems could lead to significant cost savings. Each option has potential, but you can only choose one and that means giving up the benefits of the others. That trade-off is your opportunity cost, and it’s the hidden factor that can make or break your business decisions.

In this article, we’ll break down what opportunity cost is, how it impacts financial decision-making, and how you can calculate it to make smart business choices in almost any scenario. 

What is opportunity cost?

Opportunity cost represents the benefits your business misses out on when choosing one course of action over available alternatives. It’s a tool for understanding the total cost of a business decision. It helps decision-makers contextualize the costs and benefits of their choices by highlighting what could’ve been gained by pursuing other options. 

Opportunity cost examples

Businesses encounter opportunity costs whenever they make decisions about how to leverage resources:

• Hiring a full-time employee vs. using a contractor: A full-time employee provides stability but comes with long-term salary and benefit costs. A freelancer may cost less upfront but won’t have the same loyalty to the company. 
• Investing in new equipment vs. marketing campaigns: Purchasing new equipment can increase efficiency and lead to cost savings, but investing in marketing can drive immediate growth and higher profits. 
• Developing a new product vs. enhancing an existing one. Expanding a product line opens new revenue streams, but improving on an already existing product can strengthen brand loyalty and customer retention.

Applying the opportunity cost formula to these scenarios helps the business make a more informed choice by moving beyond revenue to explore the trade-offs in efficiency, flexibility, and long-term growth potential of each option.

The opportunity cost formula

Fortunately, there’s a straightforward equation to help quantify these gains and losses. The opportunity cost formula measures the value of an expected trade-off between one option and another. To calculate the opportunity cost of a course of action, subtract the return of your chosen option from the return on your second choice option:

Opportunity Cost = Return on Second Choice Option - Return on Chosen Option

Let’s say a company has $500,000 to invest and is deciding between hiring more sales reps or boosting the marketing budget. Hiring new sales reps could generate  $800,000 in revenue, while increasing the marketing budget has an estimated return of $600,000 in revenue. To find the opportunity cost of investing in more marketing, the company subtracts $600,000 from $800,000. The $200,000 represents what the company gives up by pursuing marketing over more sales reps. 

Or, if we plug the numbers directly into the formula for opportunity cost:

Opportunity Cost = Return on Second Choice Option - Return on Chosen Option

Opportunity Cost = Return on Sales Reps - Return on Marketing

Opportunity Cost = $800,000 - $600,000

Opportunity Cost = $200,000

This tells us that hiring new sales reps may be the better decision because increasing the marketing budget instead has an opportunity cost of $200,000.

How to calculate opportunity cost: 5 steps

To really benefit from the opportunity cost formula, you’ll need to understand each part of the equation. The process below breaks the equation down into discrete steps so you can feel confident that your calculations incorporate all the important variables. 

Step 1. Explore available options

Before you can calculate opportunity cost, you need to understand the actual opportunities available to your business. This could mean deciding between two investments, choosing how to divide your budget, or identifying the most effective way to allocate resources. Typically, each option comes at the expense of another, and you need to have a clear view of what’s on the table and the relationships between choices. 

Step 2. Assess possible advantages

Opportunities don’t only come with costs. They also, hopefully, deliver value and benefits to the business. A sound financial decision, therefore, needs to place opportunity cost in the context of the expected return of each choice. 

Step 3. Identify the costs and benefits

Every decision carries costs, and some are easier to see than others. Explicit costs, the kind that show up on your balance sheet as liabilities, can take on more significance because they’re easy to see. Forgetting implicit costs, like delays in production, additional employee training time, or missed opportunities, are more challenging to quantify but can increase the overall outlay associated with a project or initiative dramatically.

Step 4. Compare the financial impact of each option using the opportunity cost formula

Once you’ve tallied up what you stand to gain and what you stand to lose for each proposed course of action, the opportunity cost formula helps quantify the trade-offs between each. By subtracting the expected return from the return on the second-best alternative, you get a clearer picture of what your decision truly costs. 

Step 5. Choose the best option based on insights

After comparing the financial impact of every possible course of action, identify the choice that best aligns with your company’s overall business strategy and goals. Opportunity cost isn’t just about choosing the highest number; it’s about appreciating what a decision means for your company’s short and long-term growth. 

Opportunity cost calculation examples

While the concept of opportunity cost is straightforward, how you deploy it changes depending on your specific business priorities. Understanding what you stand to give up vs what you stand to gain involves looking at potential investments from multiple angles and tweaking your math to capture all the expenses that come with a specific option.

Capital allocation example

If your business prioritizes the highest possible return on investment, applying the opportunity cost formula with an emphasis on capital expenditure vs expected return can help identify the option that best aligns with your business goal of maximizing economic profit.

Example: A company has $1 million to invest and must choose between increasing production or upgrading equipment. More production would generate an estimated $1.5 million in revenue, while upgrading would save $1.2 million in costs associated with repairs, maintenance, and work stoppages. Because the $1.5 million outweighs the $1.2 million in costs, the company opts to expand operations. 

Business decision-making example

If your business is focused on long-term profits and market positioning, you might use the opportunity cost formula to assess the trade-offs of strategic investment choices over short-term gains.

Example: A fashion brand is trying to decide whether to expand into a new market or launch a new line of accessories. The cost associated with expanding is $1 million, while launching a new line carries an expense of around $1.5 million. The brand estimates, however, that the addition of an accessories line will strengthen overall brand perception and allow it to raise prices. It decides to proceed with a new line, reasoning that the increased revenue will offset the higher upfront opportunity cost over time. 

Resource allocation example

For businesses struggling to decide on the best use of time and talent, the opportunity cost formula can help direct resource allocation toward the most profitable initiatives. 

Example: A manufacturing company wants to generate as much profit as possible in the short term and must decide whether to devote materials, labor, and production capacity to high-end products with a 30% profit margin or budget-friendly versions with a 20% profit margin. The high-end products are expected to generate $200,000 in revenue, while the budget-friendly line would bring in $250,000 due to higher volume. The company opts for resource allocation that favors the budget-friendly line.

Key factors to consider when evaluating opportunity cost 

The basic formula for calculating opportunity cost gives you a starting point when considering your options, but it doesn’t always tell the whole story. To make the best investment decisions, you’ll need to go deeper and factor in additional variables like risk, time frame, and the mix of implicit and explicit costs associated with each option. 

Navigating risk and uncertainty

Every spending decision comes with risk attached, and properly calculating opportunity cost means weighing any expected return against the possibility of losses. In general, the greater the uncertainty, the higher the opportunity cost of committing to one option over another. By factoring risk, you potentially avoid costly mistakes and protect your business’s profit. 

Example: A logistics company is weighing the possibility of entering a new market with an unstable regulatory environment. Under current rules and regulations, the company stands to gain a return of $2 million annually. A shift in policy, however, could cause costs to spike and cut profits in half. The uncertainty increases the opportunity cost of the expansion and leads the company to consider other markets. 

Considering the time frame

The time frame for your decision can also impact how you evaluate opportunity costs. A short-term gain might come at the expense of a bigger, long-term investment, so you need to balance immediate returns against future growth potential to evaluate the cost of a given decision.

Example: A software company can launch a new feature in six months with existing resources or invest $200,000 in new developers and release it in three months. Waiting saves the upfront cost of new salaries, but the company will forego $500,000 in delayed sales. The company decides that the opportunity cost of delaying warrants hiring new developers to release the feature sooner.

Implicit and explicit costs

To fully understand opportunity cost, you need to factor in both explicit costs related to your decision, like rent, wages, or capital expenditures, and implicit costs, like lost productivity or missed opportunities.

Explicit costs are easy to track on balance sheets, but implicit costs don’t show up as direct costs and can be easy to miss. Failing to take them into account when working out the opportunity cost of a business decision can have significant consequences.

Example: A law firm owns an office building in a prime downtown location. The partners must decide whether to keep using it as the firm’s primary workspace or rent it out for an additional $100,000. If they opt to rent the building, they’ll need to lease office space elsewhere, which will cost them around $60,000 per year. They also estimate that moving to a less central address will lead to $40,000 in lost productivity.

The $40,000 in productivity is an implicit cost of renting the building. It’s money the firm won’t make but not a loss that would appear on its balance sheet. The total cost of moving, then, is $100,000: $60,000 for new space plus $40,000 in lost business.

Had the partners not taken into account the implicit cost of lost productivity, moving might’ve seemed like a no-brainer. Once they factor in the additional $40,000, however, the prospect of moving looks to break even at best. 

Opportunity cost and capital structure

Opportunity cost influences capital structure—the mixture of debt and equity your company uses to fund operations and growth—by shaping how your business evaluates the trade-offs of different financing options. 

Taking a loan instead of offering equity in your business allows you to retain control but will add interest payments to the balance sheet. Issuing equity avoids the obligations of debt but dilutes your ownership and future profit. The right capital structure balances the opportunity costs associated with each to help you find the funding solution that best aligns with company goals and priorities. 

Example: IntelliTool needs to raise $5 million to scale and must decide between taking a loan at 10% interest or selling 20% of its shares. If the company opts for debt, it adds $500,000 annually in interest payments, which adds up to $5 million in interest over the ten-year life of the loan. Issuing shares avoids the cost of debt but means permanently sacrificing 20% of all future profits. 

The company projects revenue growth of 30% after scaling, which works out to an additional $1.5 million in annual revenue the first year. If IntelliTool issues shares, investors will claim $300,000. But as revenue scales to $10 million, investor payouts grow to $2 million annually, which means a total cost of $10 million over 10 years.

By comparing total opportunity cost over ten years—$5 million for debt vs $20 million for shares—ItelliTools can select a capital structure that best aligns with the company’s long-term goal to maximize economic profit.

What is the difference between opportunity cost and risk?

Opportunity cost measures the value of the next-best alternative, while risk reflects the uncertainty about the outcome of an investment. 

Example: Widgets Inc. is trying to decide between expanding into a new market or upgrading existing operations. The opportunity cost of expansion is the potential gains from improved efficiency at home, while the opportunity cost of upgrading is the loss of new revenue streams. 

Both options also carry risks. Widgets might opt to expand into a new market and encounter soft demand or regulatory hurdles that eat into profits. Upgrading could fail to yield the expected return in efficiency required to offset the cost of new equipment.  

Any investment, even a relatively cautious one likely to generate high returns, carries a degree of risk, and businesses typically prefer to understand their exposure before committing. What looks like a great decision in current market conditions may prove very expensive during a downturn, so it’s important to evaluate multiple scenarios.

What is the difference between opportunity cost and sunk cost?

The difference between opportunity cost and sunk cost is perspective and time. While opportunity cost focuses on the potential expense of future choices, sunk cost measures past expenses already incurred. 

Because sunk costs represent money that the business can’t recover, they don’t play a role in decision-making for new spending. Typically, finance professionals analyze them when trying to understand why a project didn’t perform as expected or when looking for opportunities to improve budgeting. 

Example: Acme Corp. spent $5,000 to upgrade its accounting software. Adoption has been slow, however, and inconsistent use is beginning to cause problems with the company’s record-keeping and compliance. Alex, the CFO, must decide whether to invest in additional training or upgrade to a more powerful version of the software. New training will cost around $5,000, while upgrading comes with a $7,000 price tag. 

The $5,000 already spent on new accounting software is a sunk cost. Alex might take it into account when analyzing budgets, but it won’t impact the choice of solution. New training and upgrading each carry an opportunity cost that Alex will need to consider when deciding how to move forward.

Streamline efficient spend management with Rippling

Rippling helps you streamline spend management by giving you a real-time view of your company’s spending and automating expense controls so you can make informed spending decisions with opportunity cost in mind. 

Rippling expense management software consolidates all of your company’s finances—including payroll, corporate cards, bill pay, and expense management–giving you an up-to-date view of spending across your company and offering unprecedented control over spending patterns.  

While most expense management solutions only allow for basic employee-manager approval chains, with Rippling’s advanced policy engine, you can set hyper-custom policies based on the vendor, dollar amount, and expense category, helping you block out-of-policy expenses with ease. You can also tee up automated workflows that help you control spend, like triggering an alert when a department’s expenses sharply increase. 

With Rippling you can: 

• Automatically route expenses and bills to the right approver every time. 
• Flag out-of-policy spending with hyper-custom policies, like by vendor or value, for further review. 
• Close the books faster with AI-powered transaction categorization and integration with your accounting systems.

FAQs on opportunity cost formula

How do you calculate cost per opportunity?

To find the cost per opportunity, divide the total cost of investment by the number of opportunities created by that investment. If you invest $10,000 in an advertising campaign and generate 1,000 opportunities for your sales reps, your total cost per opportunity is $10. This metric helps finance managers and other decision makers in charge of resource allocation measure the value of specific investments and identify opportunities for cost-cutting. 

How do you calculate opportunity cost per unit?

To calculate opportunity cost per unit, divide your total opportunity cost by the total number of units foregone. If you have an opportunity cost of eight and you forego four units, your opportunity cost per unit is two. By comparing the opportunity cost per unit in different scenarios, businesses gain insight into explicit costs and implicit costs per unit when comparing alternatives.

What is the formula for opportunity value?

The formula for opportunity value is: expected return of chosen option - expected return of foregone option. For example, if the expected return of your chosen option is six, and the expected return of your foregone option is two, your total opportunity value is four. Calculating opportunity value can help you quantify the net benefit of a decision versus opportunity cost, which quantifies what you’ve sacrificed. Finance managers typically need both numbers to assess an investment’s value and guide decision-making around resource allocation to maximize economic profit and overall returns.

This blog is based on information available to Rippling as of March 17, 2025.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.