What is Sunk Cost?
What is Sunk Cost? Do you include it in cashflow when calculating NPV?
What is Sunk Costs?
Sunk costs are unavoidable (incurred in the past) cash outflows, no longer relevant to influencing whether a project should be undertaken. Hence, sunk cost should be ignored.
Example
$10,000 payment to be made to a marketing company for assessing the market for a project which costs $125,000, and yields net cash flows of $75,000 for 2 years when the discount rate is 10%. Should the project be taken on?
Project NPV if:
(incorrectly) include marketing costs:
-135+75/(1.1)1+75/(1.1)2
= -4.8 => reject
(correctly) exclude marketing costs:
-125+75/(1.1)1+75/(1.1)2
= 5.2 => accept