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Sunk Costs

29 April, 2015 - 15:03

Sunk Costs are expenditures which a company has already spent on a project. It is important to realize that sunk costs are already spent, and are not factored into an NPV equation. For example, if your corporation hires a consulting firm to evaluate customer reaction to a new product line, that is not included in the NPV calculation. Whether or not you decide to initiate the new product line, you already spend money on the consultants.

It is also important to understand the difference between opportunity cost and sunk costs. Lets suppose XYZ Corp. buys a parcel of land for $100,000. They do not do anything with this land for a number of years, and then decide to build a factory on it. When calculating the NPV of the factory, the cost of the land is NOT a sunk cost. It is still possible to sell the land or do something else with it, and it therefore must be included.