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CA Foundation · Business Economics · Nature and Scope of Business Economics

Rajesh Manufacturing Ltd., a Delhi-based textile firm, is deciding whether to expand its production capacity. The firm estimates that expansion will cost ₹50 lakh upfront and generate additional annual profit of ₹12 lakh for 5 years. However, the firm could alternatively invest the same ₹50 lakh in government securities earning 8% per annum. Using the concept of opportunity cost from Business Economics, what should Rajesh Manufacturing consider?

Business Economics requires managers to compare all alternatives when making decisions. Rajesh should consider that by investing ₹50 lakh in expansion earning ₹12 lakh annually, it forgoes ₹4 lakh annually from government securities. The true economic benefit is the difference: ₹8 lakh per year.

  1. AOnly the ₹12 lakh annual profit, because it is a tangible cash flow from operations
  2. BThe ₹12 lakh annual profit minus the ₹4 lakh annual return from government securities, as the latter represents the opportunity cost of not investing in securitiesCorrect
  3. CThe total ₹60 lakh profit over 5 years, ignoring alternative uses of capital
  4. DThe ₹4 lakh annual return from government securities only, because opportunity cost always equals the return foregone

Explanation

Opportunity cost in Business Economics means the benefit sacrificed by choosing one option over the next best alternative. Here, Rajesh foregoes ₹4 lakh annual returns (8% of ₹50 lakh) from securities if it invests in expansion. Therefore, the real economic benefit of expansion is ₹12 lakh minus ₹4 lakh = ₹8 lakh annually. Option 0 ignores opportunity cost entirely. Option 2 ignores the time value concept. Option 3 incorrectly states opportunity cost is *only* the foregone return, rather than part of the comparison.

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