Opportunity Costs - Business Finance - ثاني ثانوي

. Link to digitat lesson 5.1 Opportunity Costs www.ten.edu.sa Oppertunity cost What is person gives up by making a choice Key Terms Opportunity cost Time value of money With every decision you make, you give up something. For example, money spent on an item gives up the opportunity to save or invest that money for the future. This tradeoff involved in every decision is commonly called opportunity cost, which is what a person gives up by making a choice. In other words, you sacrifice something (time or money) to obtain something else that you consider more desirable. The opportunity costs of your resources should be considered when making personal and financial decisions (see Figure 5.2). FIGURE 5.2 Personal and Financial Opportunity Costs Panwal and narutal Decisionis Binding, winy Investing, bong) Pul Opportunity Cost (tume hulth (time value of money) 190 Business Finance 5.1a Personal Opportunity Costs Time is a commonly overlooked resource available to every person. A personal opportunity cost occurs when time used for one activity cannot be used for other activities. Time used for studying, working, or shopping will not be available for other uses. Like other resources, your time must be managed to achieve your personal goals and to satisfy your values.

The health of a person is another possible personal opportunity cost. Eating unhealthy foods, not getting enough rest, or not exercising can result in illness, school absences, and higher medical expenses. Your personal resources (time, energy, health, abilities, knowledge), along with finances, require careful decision making. 5.1b Financial Opportunity Costs Would you rather have SAR 100 today or SAR 105 a year from now? How about SAR 120 a year from now instead of SAR 100 today? Your choice will depend on current needs, future uncertainty, and current rates of earnings. If you wait to receive your money in the future, you want to be rewarded for the risk. The time value of money calculates increases in an amount of money as a result of its earnings over time. Saving and investing a Riyal instead of spending it today results in a future amount greater than a Rival. Spending, saving, and investing money involves financial opportunity costs. Common examples include: ⚫ Spending money from savings means lost future earnings; however, the purchase may have a higher priority than the earnings. ⚫ Borrowing to make a purchase involves the opportunity cost of paying interest on the loan, but your current needs may make the tradeoff worthwhile. The opportunity cost of the time value of money is also present in these financial decisions: ⚫ Setting aside funds in a savings plan with little or no risk has the opportunity cost of potentially higher returns from an investment with greater risk. • Making annual deposits in a retirement account can avoid the opportunity cost of having inadequate funds later in life. ⚫ Purchasing a new automobile or home appliance has the potential benefit of saving money on future maintenance and energy costs. Turn valusid minity Increases in an amount of money as a result of its earnings over lime وزارة التعليم CHAPTER 3 Opportunity Costs and the Time Value of Money 191

M 192 Business Finance 5.1c Interest Calculations Three amounts are required to calculate the time value of money for savings in the form of interest earned: 1. The amount of the savings (commonly called the principal). 2. The annual rate. 3. The length of time the money is on deposit. These three items are multiplied to obtain the amount of simple interest. Simple interest is calculated as follows: Amount in savings Annual interest rate × Time period = Interest EXAMPLE Assume SAR 1,000 is invested today at 3% for a year. Calculate the amount of simple interest earned. The simple interest earned-(SAR 1,000) x (0.03) x (1 year) = SAR 30. You Try It What would SAR 2,000 invested today at 4% for a year earn? The increased value of money from interest earned involves two types of calculations 1. Future value; the amount available at a later date. 2. Present value; the current value of an amount in the future.

Four methods are available for calculating time value of money. 1. Formulas: Traditionally, math notations were used to compute future value and present value. 2. Financial Calculators: Specialized calculators with financial functions use appropriate keystrokes to perform future value and present value calculations. 3. Spreadsheets: Spreadsheet software has built-in financial formulas that include future value and present value calculations. 4. Websites and apps: Time-value-of-money calculators are available online and through mobile devices. (Note: In this chapter, the four basic time value of money calculations are explained using the formula, financial calculator, and spreadsheet software methods. Different financial calculators may require slightly different keystrokes.) Financial calculators generally have five special keys for calculating time value of money: N number of time periods 1 rate for the time period PV current amount (present value) PMT periodic payment (annuity) FV future amount (future value) BAR A financial calculator وزارة التعليم Spreadsheet software CHAPTER Opportunity Costs and the Time Value of Money 193

134Business Finance Exercises Choose the correct answer. 1. Opportunity cost refers to what a person gives up when making a decision. True/False 2. Which of these is not needed to calculate simple interest? a. annual rate b. length of time c. currency exchange rate d. amount of savings 3. If SAR 5,000 is invested at 3% for one year, what is the amount of simple interest earned? a. SAR 100 b. SAR 120 c. SAR 150 d. SAR 180