Introduction to Sunk Cost Examples
The examples of Sunk Costs provide an idea to the user about the most common type of Sunk Costs examples present. It is not possible to provide each and every type of example of the sunk cost, as there are multiple such Sunk Costs examples. Sunk costs are those costs whose occurrence has already taken in the past years and the same cannot be recovered. These are not considered in the decision-making process and are irrelevant for that purpose. The following Sunk Costs Examples have been provided considering the different situations.
Examples of Sunk Cost
Below are a few examples of Sunk Cost
- There is a company that is planning to expand its business and want to launch a new product on the market. It spends $ 8 million for the research, development, and study of the market in order to determine that whether the product which the company has selected will be profitable or not if it is launched in the marketplace. The research and development of the market conclude that the product if launched will not give the profits to the company and will be heavily unsuccessful. Therefore, the cost already spent on the research and development of $ 8 million will be the sunk cost. As the product is not profitable according to the study, the company should not launch the new product in the market. Also, the Initial investment on the research and development should not be taken into consideration while making decisions about the product launch as such cost once spent, cannot be recovered.
- XYZ Ltd. is the manufacturing company, producing and selling cricket shoes in the market. The company took premises used for the manufacturing of the product on the lease for a period of 3 years. Also, the company has the machinery installed in the premises which are used for making the cricket shoes. At present, the company is producing the basic model of cricket shoe cost of which comes to $ 40 per unit of cricket shoes and sells the same at the price of $ 55 per unit of the cricket shoe. This gives the company, a profit of $ 15 per cricket shoes ($ 55 – $40). Recently it was found by the management of the company that there is demand for the premium cricket shoes in the market where the additional cost of $ 20 will be incurred for the production of the premium cricket shoes making the total cost of production to $ 60 per unit of premium cricket shoes ( $ 40 + $ 20) . If the premium cricket shoes are produced by the company then it can be sold in the market at the price of $ 85. The total profit which the company is going to earn in case it decides to sell the premium cricket shoes comes to $ 25 ($ 85 – $60). In the case of basic cricket shoes, the company is earning a profit of $ 15 per unit and in case of the premium cricket Shoes, the company will be earning a profit of $ 25. So, the management of the company decides to start the production of the premium cricket shoes as by this company will be able to earn an extra $ 10 per unit ($25 – $ 15).
In this case, while deciding which product the company should produce and sell the cost of building taken on lease for the period of 3 years and the machinery will be treated as the sunk costs because the company has to incur the expenditure on lease and machinery irrespective of the decision to make either of the products. Thus these costs will not form part of the decision-making process.
- ABC Ltd. Construction Company started the development of the new housing sub-division. It purchased the initial construction materials and the other framing material costing $ 5 million in total. After investing this much money, suddenly, the crisis started in some of the different industries in the market including the banking industry causing the recession. This leads to the fall out of the housing market as well. In effect of that, the worth of the land purchased by the company also decreased even below the purchase price of land to the company. The management of the company now is worried about the situation and not sure about future decisions to be taken. If it abandons the project then the company will have to face the loss of $ 5 million and if it continues the construction of the project then the company will have to incur the additional cost of $ 10 million for completing the project undertaken.
In the present case, the amount of $ 5 million already spent is a sunk cost as the company will no longer be able to recover it. So, it should not form a part of the decision-making process. The management should make the decision as per the current banking and housing industry environment. Taking the decision without the consideration of sunk costs will let the management to abandon the project as it will limit their losses incurred to $ 5 million as otherwise, they might have to lose the additional $ 10 million if it decides to complete the project. The company can use the additional $ 10 million for some other project which suits better to the prevailing business environment.
Conclusion – Sunk Cost Examples
The cost that the entity has already incurred and cannot be recovered is known as the sunk cost. These costs should not form the part of decision-making process i.e., the person making the decision regarding whether to continue the investment in the ongoing project, should not consider the sunk cost as these costs are the cost which cannot be recovered and instead of that one should consider only the relevant costs while taking the decision. Some of the managers, however, consider the sunk costs as well while making the decision and continue the investments in the projects because of the amounts already invested by them in the project and fear of losing the money already invested. Practically, the amount already spent earlier by them should be considered as the sunk costs, and therefore should be excluded while taking the decision about the further investments.
This is a guide to the Sunk Costs Examples. Here we discuss the top 3 practical sunk cost examples with a thorough explanation. You can also go through our other suggested articles to learn more –
- Real life examples of Monopoly
- Bootstrapping Examples
- Fixed Costs Example with explanation
- Purpose of Income Statement
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.8 (979 ratings)
250+ Online Courses
Investment Banking Course (with 25+ Projects)
Financial Modeling Course (with 15+ Projects)
Equity Research Training Course (with 6+ Projects)
Project Finance Course
Business Valuation Course (with 10+ Projects)