Suppose you inherit $10,000 and decide to use the money to start a lawn-care bus

Question

Suppose you inherit $10,000 and decide to use the money to start a lawn-care business. You purchase a truck and a mower for $10,000 and start mowing lawns. Your annual cost for fuel and other supplies is $2,000. Now, instead of investing your money in the lawn-care business you could have invested the $10,000 in a bank account earning 8 percent annual interest. Additionally, you could have earned $30,000 in another job if you didn't start your own business. So what is your total annual cost (including opportunity cost) of operating your own lawn-care business?
Explain.

Explanation / Answer

We can use the principle of opportunity cost to compute your costs. In addi- tion to the $2,000 expense for fuel and other supplies, we must include two other sorts of costs: • Opportunity cost of funds invested. You could have invested the $10,000 in a bank account. If the interest rate on a bank account is 8 percent, the annual cost of the truck and mower is the $800 you could have earned in a bank account during the year. • Opportunity cost of your time. Suppose that you could have earned $30,000 in another job. The opportunity cost of your time is the $30,000 you sacrificed by being your own boss. Adding the $800 cost of funds and the $30,000 cost of your time to the $2,000 fuel cost, the cost of doing business is $32,800 per year.

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