Financial Planning

What Is the Opportunity Cost of Investing in a New Firm?

The Opportunity Cost of Investing Human capital is very important to investors and other entrepreneurs. In general, capital always costs less than the capital obtained through production. If you purchase raw materials, plant, and machinery yourself and run the operation yourself, the cost to produce the same item over again is zero.

However, it can be difficult to operate a manufacturing business or own a small business without having at least some human capital. In order to successfully invest in human capital, we must consider three important questions:

Cost of training employees

Staff can take a significant amount of time to train. If you are just starting out in business, or if you are going to expand your current operations, you may have a staff of raw material workers. It will cost you to train these workers so that they are better able to do the jobs that you are requiring of them. The cost of training should be calculated into the cost of capital so that you know how much capital you will need to finance the operation.

Cost of purchasing raw materials

The cost of purchasing a product from another company, say, for example, soybeans, will depend on what the price of that product is at the time when you purchase it. If the price is relatively low at the time you order the product, you may save money by purchasing the product yourself and processing it yourself. However, if the price is very high at the time of purchase, you should use a production facility to process the soybeans for you.

Cost of capitalizing

Here, “capitalizing” means to borrow money in order to finance the production of a product. Capitalizing involves taking a loan that is in the form of equity (something that your firm owns) or buying capital (a piece of property). A venture capitalist may provide startup capital (a lump sum of cash) or source the money (to which you owe no taxes on). Seed capital also refers to a small amount of money that a business uses to manufacture its products. You can also use retained earnings as capital; however, you should not use profits that come from an investment activity (such as the sale of a product) as equity because you do not have ownership in that firm.

The opportunity cost of selling a product

Selling a firm’s product involves the payment of a commission to a salesperson who represents the client. Determining the amount of your potential income from such a sale is complicated; however, you can determine it by looking at what your firm would owe to a third-party buyer who purchases the product based on the number of customers you represent.

The opportunity cost of financing an acquisition or startup venture

The opportunity here is the difference between what your firm would owe a bank if it were to file for bankruptcy and what it would owe if it acquired the company from a private investor. When buying a firm, an angel investor or venture capitalist is typically attached to the firm’s future success in a particular market. Because of this, they are willing to absorb a large amount of risk. However, because their involvement is only temporary, it results in an attractive return on investment for them. Of course, when they leave, so too do your profits.

The opportunity cost of trying to raise additional capital

This involves a lot of common sense, but it is often overlooked by most new business owners. If you are planning to start a business in a relatively untapped market, you must factor in the time and expense required to travel to that market, as well as the time and expense required to obtain necessary licenses, meet the requirements for local funding sources, and secure potential investors’ approval for your business.

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