Sunk cost

Definition

A sunk cost is an expense that has already been incurred and cannot be recovered. It should not influence current decision-making as it remains constant regardless of future outcomes.

5 Must Know Facts For Your Next Test

1. Sunk costs are irrelevant to future business decisions since they cannot be changed.
2. Managers should focus on relevant costs, which include only future costs that will change as a result of the decision.
3. Sunk costs can include expenses such as past R&D expenditures or marketing campaign costs.
4. Ignoring sunk costs helps prevent the fallacy of committing more resources to a failing project.
5. In short-term decision making, it's crucial to distinguish between sunk costs and avoidable or variable costs.

Review Questions

• What is a sunk cost and why is it irrelevant in decision-making?
• Can you provide an example of a sunk cost in business operations?
• Why should managers ignore sunk costs when making decisions?

Related terms

Opportunity Cost:

The potential benefit lost when one alternative is chosen over another.

Relevant Cost: Costs that will be affected by a managerial decision and therefore should be considered in decision-making.

Fixed Cost: A cost that does not change with the level of output produced within certain limits.