The Effects of Opportunity Costs on Project Investment Decisions: A Replication and Extension

Abstract

Normative economic and accounting theory suggests that opportunity costs ought to be used as an input in economic decisions. Furthermore, the theory suggests that the opportunity costs should be considered equally with any direct costs which may be involved (see, for example, Dopuch, Birnberg, and Demski [1974] and Baumol [1977]). Little research has been carried out, however, to determine whether decision makers do in fact behave as the theory suggests. In two previous studies, Becker, Ronen, and Sorter [1974] and Neumann and Friedman [1978] investigated whether subjects would use opportunity cost information in decisions if they have it available. In the Becker, Ronen, and Sorter (BRS) study, two types of costs were defined: outlay costs and opportunity costs. Outlay costs are negative cash flows, such as for materials, labor, and variable overhead. Opportunity costs reflect a foregone opportunity to receive some positive cash flows. Examples are interest foregone on invested capital or rent not collected because a building was used rather than leased to a third party. BRS presented subjects with a series of choice between two projects, one of which included some opportunity cost information and one of which did not. A statistically significant number of subjects made decisions that indicated they either ignored or discounted the opportunity cost information. Neumann and Friedman (NF) modified the BRS experimental instrument by presenting explicit information about opportunity costs for both