Define opportunity costs and explain their role in capital budgeting.

An opportunity cost is income potentially available from a resource that will be lost if that resource is used in a project. Usually the resource is already owned and therefore seems free. For example, if a project requires a building, and the company already has an empty one, it might seem that it could be used in a project at no cost. The building seems free because, no money has to be spent to acquire it. But if it could be sold or rented, access to that income is lost by using the building in the project. The lost income is the building's opportunity cost, because the company must give up its ability to realize that income in order to dedicate the building to the project. Opportunity costs should be explicitly included in project cash flow estimates.