Sunk Costs
Sunk costs are expenditures that have already been incurred and cannot be recovered, regardless of future decisions or project outcomes.
Explanation
Sunk costs represent money, time, or resources that have been spent and cannot be reclaimed. The critical principle is that sunk costs should not influence future project decisions. Whether to continue, modify, or cancel a project should be based on future costs and benefits, not on how much has already been invested.
The sunk cost fallacy—sometimes called "throwing good money after bad"—occurs when decision-makers continue investing in a failing project because they have already spent so much. Rational decision-making requires ignoring sunk costs and evaluating the go-forward economics independently.
On the exam, sunk cost questions typically test whether you understand that past expenditures should not drive future decisions. If a question describes a project that has spent $2 million but now looks unprofitable, the $2 million is a sunk cost. The decision to continue should depend only on whether the remaining work will produce value exceeding its remaining cost.
Key Points
- •Money already spent that cannot be recovered
- •Should NOT influence future project decisions
- •The sunk cost fallacy leads to continued investment in failing projects
- •Rational decisions consider only future costs and benefits
Exam Tip
Sunk costs should never factor into the decision to continue or cancel a project. Always evaluate go-forward decisions based on future costs and expected benefits only.
Frequently Asked Questions
Related Topics
Opportunity Cost
Opportunity cost is the value of the next best alternative that is forgone when a decision is made to pursue a particular project or course of action.
Project Selection Methods
Project selection methods are the techniques organizations use to evaluate and choose which projects to pursue, including mathematical models (NPV, IRR, BCR) and comparative approaches (scoring models, peer review).
Net Present Value (NPV)
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time, used to assess the profitability of a project or investment.
Business Value
Business value is the net quantifiable benefit derived from a business endeavor, encompassing tangible elements like revenue and market share, as well as intangible elements like brand recognition, public benefit, and strategic alignment.
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