SUNK COST

THE COST W

H ICH I S

SPENT IN

THE PAST AND C

ANNOT BE

RECOVERED IN THE PAST.

OTHER NAMES• Prior year cost• Sunk capital• Embedded cost• Retrospective cost• Stranded cost

Sunk

cost

Independent of future

costs

Cannot be recovered

Incurred in past

EXAMPLES1. Marketing study2. Hiring bonus3. Research & development4. Training

OPPORTUNITY COST• Value of choice which is not chosen• The next best alternative cost available • Which a person sacrifices when he choses the

other cost over another• Plays crucial role in the capital budgeting

decisions• Types - implicit costs and explicit costs

SUNK COST FALLACY• A trap which enables a investor to invest more

in the sunken cost to earn profit• Describes the emotional difficulty attached with

the investment• Give rise to the sunken cost dilemma

EXAMPLE OF SUNK COST FALLACY

SUNK COST BIAS• A thinking trap • Expecting something from sunk investment• A long term relationship which we don’t want to

abandon as lot of money and time invested in it

HOW TO AVOID IT?• Quickly admit mistakes and try to take pride in

recognizing the costs• Focus on current course of action• Take care of long term objectives• Should not waste resources on bad move

CALCULATION OF SUNK COST

F O R A E Q U I P M E N T F O R A P R O J E C T• First of all identify all equipment

that can be salvaged in the project. It includes tools and equipment that can be resold.

• Now calculate the sunk cost for salvaged equipment.

• Calculate the cost of non-salvaged equipment. (Purchase price of equipment – depreciation)

• Total cost of labor that is used in the project up to the date.

• Sunk cost for the project is the sum total of equipment sunk cost, cost of equipment that cannot be salvaged and the cost of labor.

Compare the new price of each object based on its make, model and serial number with the equipment to be replaced

Find the relizable salvage value of each product.

subtract the present realizable salvage value from the book value.

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