Steve Collins runs the SC Steak House in London. The restaurant has been in business for 30 years and is one of the most recommended steak houses in London.
The total value of the restaurant’s capital stock is £4 million, which Steve owns outright. This year, the restaurant earned a total of £1.8 million after out-ofpocket expenses. Without taking the opportunity cost of capital into account, this means that Steve is earning a 45 percent return on his capital. Suppose that risk-free bonds are currently paying a rate of 13 percent.

a. What is meant by the “opportunity cost of capital”?

b. Explain why opportunity costs are “real” costs even though they do not necessarily involve out-of-pocket expenses.

c. What is the opportunity cost of Steve’s capital?

d. How much excess profit is Steve earning?