Sunk cost

Sunk costs, which are also called stranded costs, are costs that have been incurred in the past. They may no longer be recovered. As such, they are usually irrelevant when making investment decisions. However, they are usually still counted.

Sunk costs, as asserted by behavioral economics, may still influence decision making in the context of loss aversion. This simply means that previous experience with a sunk cost may deter someone from spending on the same object to avoid a repeat loss. The amount that was lost is immaterial, though.

This serves as a critique to rational economics, because it proves that investment decisions are not always made based on rational data. The implications of this have been published in the work of Daniel Kahneman, Nobel Prize Winner for Economics.

Sunk costs are also taken in opposition to prospective costs. Prospective costs may be incurred in the future and may still change. Theoretically, these have much more impact on future investment decisions.

Sunk costs are also very different from economic losses. If a piece of company equipment is bought and eventually becomes useless to the company that purchased it, the company may opt to sell it. The difference between the original and resale price may be considered the loss.

However, if the company will benefit more from the sale of the equipment, it is still more advisable that it be sold. The purchase price is no longer relevant. After all, it is highly unlikely that it will ever be recovered no matter which decision the company makes.

Cost overruns may also be caused by sunk costs.

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