Total cost of the zippers for one year is $36,000 (60,000 X $.60). The company has a choice: It can purchase all of the zippers at the beginning of the year, or it can purchase them as it needs them, which is 5,000 per month. If American Coat Company purchases 5,000 zippers monthly, it will pay $3,000 per month for them (5,000 × $.60). If American Coat Company decides to purchase all the zippers at the beginning of the year then the total additional cash outlay for the company in January will be $33,000 [$36,000 ? (5,000 zippers needed the first month X $.60)] The money not needed for zipper purchases could be invested at 8%. The amount of money not needed for zipper purchases would start the year at $33,000 and decline each month until at the end of the year, it would be zero. Therefore, the average balance of the investable funds would be ($33,000 + $0) / 2, which is $16,500. An average balance of $16,500 invested at 8% per annum for one year equals income of $1,320 over the one-year period. That is the income given up by purchasing all of the zippers at the beginning of the year, and that is the opportunity cost.
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This answer results from multiplying $33,000 (the difference between the cost to buy 60,000 zippers and the cost to buy 5,000 zippers) by the interest rate at which the unused funds could be invested. However, the investable funds amount will decline each month because additional zippers will need to be purchased each month, if the company purchases the zippers it needs monthly. Therefore, the amount of income lost should be based on the average balance of the investable funds over the course of one year, not the amount of investable funds in January.
This answer results from using an average investable balance of $18,000 for the year, calculated as ($36,000 + $0) / 2. However, the investable balance begins the year at $33,000, not $36,000, because $33,000 is the difference between the cost to purchase in January all of the zippers at the same time ($36,000) and the cost to purchase only the first month's requirement ($3,000).
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