---
title: "Overhead cost and opportunity cost"
subject: "Engineering Economics"
chapter: 1
key: "semester_6/engineering_economics:overhead-opportunity-cost"
source: https://www.bctengineer.com/q/semester_6/engineering_economics/overhead-opportunity-cost
site: BCT Engineering
---

# Overhead cost and opportunity cost

Engineering Economics · Chapter 1: Introduction

- Asked in: 2067 Mangsir, 4 marks
- Video: [9 Types of Most Common Costs in Business | From A Business Professor](https://www.youtube.com/watch?v=HAU_R6vLrco) — Business School 101
- Answer checked by Claude Opus 5.5 (high effort) on 2026-10-14
- Page: https://www.bctengineer.com/q/semester_6/engineering_economics/overhead-opportunity-cost
- Whole chapter: https://www.bctengineer.com/md/semester_6/engineering_economics/chapter-1

## Question

Explain overhead cost and opportunity cost.

## Short answer

Overhead cost is indirect cost (indirect material, labour, expenses) that cannot be traced to a single product, so it is allocated via an absorption base. Opportunity cost is the benefit lost when choosing one alternative over the next best, a non-cash economic cost relevant for decision-making.

## Answer

#### Overhead cost
Overhead cost (indirect cost) is the total of indirect material, indirect labour and indirect expenses. It cannot be traced to a single product or job, so it is distributed over products using an allocation base (labour hours, machine hours, % of direct labour).

- Types: **factory overhead** (factory rent, power, supervisor wages, machine depreciation), **administration overhead** (office salaries, stationery), and **selling and distribution overhead** (advertising, delivery).
- By behaviour: fixed, variable or semi-variable.
- Overhead absorption rate = budgeted overhead / budgeted base (e.g. Rs 600,000 / 20,000 labour hours = Rs 30 per hour).

#### Opportunity cost
Opportunity cost is the benefit lost by giving up the best alternative when a resource is used for one purpose. It is not a cash payment, but it is a real economic cost and must be included in decisions.

Example: A company owns a plot it could rent out for Rs 200,000 per year. If it builds a factory on it, the Rs 200,000 rent forgone is the opportunity cost of the land, even though no cash is paid. Similarly, if Rs 1 million is invested in a machine instead of a bank deposit earning 8%, the lost interest of Rs 80,000 per year is an opportunity cost.

This is also why the minimum attractive rate of return (MARR) is set at the return of the best investment opportunity forgone.

## Check yourself

The answer's key points as multiple-choice questions, with the correct option and why.

1. Overhead cost is:
   A. Cost traced to one product
   B. Only factory rent
   C. Direct labour
   D. Indirect material, labour and expenses spread over products by an allocation base
   Answer: D. It cannot be traced to a single product. (Key point: Overhead)

2. Budgeted overhead Rs 600,000 and 20,000 labour hours give a rate of:
   A. Rs 30 per hour
   B. Rs 3 per hour
   C. Rs 300 per hour
   D. Rs 12 per hour
   Answer: A. 600,000/20,000 = 30. (Key point: Absorption rate)

3. A firm builds a factory on its own plot that could be rented for Rs 200,000 per year. The opportunity cost is:
   A. Construction cost only
   B. Rs 200,000 per year rent forgone
   C. Plot purchase price
   D. Zero because no cash is paid
   Answer: B. Benefit lost from the best alternative is a real cost. (Key point: Opportunity cost)

4. MARR is linked to opportunity cost because it is set as:
   A. The inflation rate
   B. The bank loan interest
   C. The return of the best foregone investment
   D. Zero
   Answer: C. It is what funds could earn elsewhere. (Key point: MARR)

## Related in Engineering Economics

- [Fixed overhead cost variance from standard card](https://www.bctengineer.com/question.md?key=semester_6%2Fengineering_economics%3Afixed-overhead-variance-standard-card) — Engineering Economics, chapter 1
- [Elements of cost; prime and overhead cost](https://www.bctengineer.com/question.md?key=semester_6%2Fengineering_economics%3Aelements-prime-overhead-cost) — Engineering Economics, chapter 1
- [Cost variance analysis from standard and actual](https://www.bctengineer.com/question.md?key=semester_6%2Fengineering_economics%3Acost-variance-analysis-9000-units) — Engineering Economics, chapter 1

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