Introduction
In this academic report, basic concepts about: The opportunity cost (COK) and the net present value (NPV) will be understood. For them we will use tools such as the appointment of renowned authors whose books are at the top of the topic and the which are specialists. In addition to this, a practical case will be taken as a closing point after having defined each of these concepts adequately and correctly.
Currently the opportunity cost is an essential factor in the vision not only of an administrator, but also in the daily life of people who face day after day to arduous decisions and therefore their consequences. The concept of security is poorly defined, being in a bubble so to speak; When people express that while they are in this place or as long as they do not invest money, it does not have to have a negative cost for them, since it is completely false what they experience is a much lower risk, but actually having the money "safe" "Is nothing more than a significant loss in terms of generating value and wealth,Therefore, this report will explain what the wrong decision is made by these people, what will be the cost or the costs of keeping the money “safe” or “at low risk”.
It can also be said of a current field entering to carve more in the business field we will enter the world of investment to be able to express more fully our indicator called VAN which means Net Present Value. In simple terms, the NPV could be explained as the financial indicator that helps us or serves to determine the viability of a project or company. After applying this indicator, measuring future cash flows, we subtract the investment that we put in at the beginning, we could obtain if the business or project is viable or not if there are still profits then it is convenient to invest in said business.
This is something that administrators should take into account to avoid misusing the money to invest or spend and thus be able to generate more value or wealth for the company.
The Capital Opportunity Cost (COK) and the Net Present Value (NPV)
1. The opportunity cost (COK)
As it could be expressed in the introduction, the mistake made by many people today is thinking that their money is safe or that it does not generate any cost for them not to invest it or get profitability from it, but they are wrong. To begin, we will cite four authors who define us in their book Cost Accounting Concepts and applications for Management Decision Making:
“When a decision is made to pursue a certain alternative, the benefits of other options are abandoned. The benefits lost in ruling out the next best alternative are the opportunity costs of the chosen action. Since no opportunity costs are actually incurred, they are not included in the accounting records. However, they are relevant costs for decision-making purposes and must be taken into account when evaluating a proposed alternative ”(Polimeni, Fabozzi, Adelberg And Kole, 2010).
Specialists express their definition of opportunity cost here. Regarding what we have said, we could conclude that the costs we incur when we start the “safe” money or when we decide not to invest in a certain offer or company project, expenses that are not included. within the accounting either of our company or within the accounting of the home. We can also appreciate that the authors give us a recommendation and imply that when evaluating proposals, it must be taken into account, it is a criterion in my opinion, this is summarized in a small phrase "This gives me more than that" and that is basically The opportunity cost is based on that, the more this gives me, at what risk and in how long, they are also factors that influence this process.
To give some concrete examples we will quote the Blog Economic Zone.
Example 1: Do I walk or taxi to work? If I walk, he will not pay money, however, from the point of view of the opportunity cost, I cannot affirm that the cost is zero, because I must take into account that walking will take me a while. If walking to work takes 30 minutes, while taking a taxi takes 10 minutes, the opportunity cost of walking to work expressed in time will be 20 minutes. If I consider that walking brings me a health benefit, the opportunity cost of going by taxi is represented by the sum of the best that I could have done with the money the taxi driver charged me, plus the health benefits that I left behind. receive for not walking.
Example 2: A classic opportunity cost example occurs when a person must decide between studying for a university degree, or working. If you decide to study, the opportunity cost is what we would receive in the best job we could find if we didn't study. This may be represented by the salary of the job, the work experience, the social prestige that that job implies, etc.
Example 3: Suppose we have a house that we own, that we do not inhabit and that we do not have to pay taxes on it. We have two alternative options: rent the house to a third party for $ 1000 per month, or not rent it. In the second case, we would not receive income, but this does not mean that the cost of not renting the house is nil, because we stop receiving $ 1000 per month. In this case, the opportunity cost of not renting the house will be represented by $ 1000 per month, less the costs that may arise from renting the house, such as the deterioration of the house due to its use, the time it takes to find tenants, etc. (Zonaeconomica.com, nd)
As we could see in the examples, the opportunity cost is used in the daily life of people and not always not investing is the best way to take in order to have the most money in the opportunities that are offered to us on a daily basis.
2. The Net Present Value (NPV)
As we could see in the brief introduction, Net Present Value is a financial instrument used to measure the viability of an investment project after an analysis of future cash flows and the initial investment we could obtain if this project is profitable or not. But on the other hand, in a field a little more theory and more profound, the following author defines VAN as follows:
“It is the most widely accepted model or method, and consists of updating net cash flows at a known rate and which is nothing more than the weighted average cost of capital, determined on the basis of pre-programmed financial resources. This rests on the criteria already outlined on previous occasions; Investment decisions must increase the total value of the company, as part of a healthy and productive administrative policy. Some authors call the discount rate, which is nothing other than the rate used in the market to determine the financial feasibility of investment projects ” (Germán Altuve, 2004).
In the author's decision you can find in technical words what was said before, the application of the NPV is used to find the profitability or viability of a project by updating the cash flows and the subtraction with the initial investment we can obtain if the project it is viable or not. For a greater and better explanation we can take these as a reference point in the following example
Statement
We receive the following investment proposal:
- Amount to be disbursed: € 20,000 In exchange, we would charge the following amounts for the next 3 years:
€ 5,000 at the end of the first year
€ 8,000 at the end of the second and
€ 10,000 at the end of the third
VAN: Sum of updated annual cash flows deducted from the investment value If we call the cash flows (collections - payments): Q1, Q2,…, Qn at the selected discount rate: k and the initial disbursement: A
NPV: sum of cash flows
being:
Q1, Q2, Q3 = 5,000, 8,000, 10,000 k = 5% (1) A = 20,000 we will have:
NPV: sum of cash flows minus disbursement
VAN - results
NPV = Sum of updated cash flows - Initial disbursement = 656.52
NPV = 20,656.52 - 20,000
VAN = € 656.52
Currently these calculations have been transferred to the financial calculators or to the spreadsheets that include functions that calculate the NPV just by entering the value of the initial disbursement, the cash flows and the discount rate.
As we could see in the present example, the calculation of the NPV did not help to predict the viability of the investment, giving us a positive rate of return.
Bibliography
Germán Altuve, J. (2004). The use of net present value and internal rate of return for the valuation of investment decisions. Venezuela, p.15. Available at:
Polimeni, R., FABOZZI, F., ADELBERG, A. and KOLE, M. (2002). Cost accounting.
3rd ed. Bogotá: McGraw-Hill, p.25.
Zonaeconomica.com. (nd). Opportunity cost. Available at:
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