Introduction / Context:
Sunk costs are expenditures that have already been incurred and cannot be changed by any current or future decision. Recognizing them—and explicitly excluding them from incremental analyses—is fundamental to sound capital budgeting and project management decisions.
Given Data / Assumptions:
- Past cash outflows that cannot be reversed.
- Balances on prior investments that remain unrecovered.
- Irretrievable capital tied up in assets without salvage in the decision context.
Concept / Approach:
Economic decisions should depend on relevant (incremental and future) cash flows. Sunk costs fail the relevance test because they will not change regardless of the chosen alternative. Including them biases decisions and can lead to the “sunk cost fallacy,” where managers throw good money after bad.
Step-by-Step Solution:
Identify which cash flows can be affected by the decision (future, incremental).Classify past outlays and unrecoverable balances as sunk and exclude them from the economic comparison.Focus on differential revenues, differential costs, opportunity costs, and salvage values that will change across options.
Verification / Alternative check:
Perform a sensitivity analysis on only those variables that can still vary with the decision (prices, volumes, operating costs, capex yet to be spent).
Why Other Options Are Wrong:
Options a, b, c each describe sunk elements; only “All of these” captures the full definition.“None of these” contradicts the accepted classification in managerial finance.
Common Pitfalls:
Allowing accounting book values to influence go/no-go choices when the book values are already sunk.Confusing sunk costs with committed but not yet spent future obligations (the latter are relevant).
Final Answer:
All of these
Discussion & Comments