Question

What is sunk costs and how is it used in replacement analysis?

Answer 1

Answer -

In economics sunk costs are those which already has been incurred and that cannot be recovered.

A sunk cost is lumpsum amount paid in the past that isn't related with future decesions.Even though economists assumes that sunk costs aren't related to future time period but in real life people make such expenditure for the betterment of future.e.g.repairing a house or motor car.

Replacement analysis is one of the important analysis in capital budgeting.The life of the asset may be reduced due to technological changes, changing economic environment etc so replacement of assets is required.The replacement of asset can be undertaken with the help of sunk cost .For the calculation of replacement cost of any fixed asset sunk cost is important determinant.Actually sunk cost is the original value of assets recorded in books with consideration of depreciation, impairment etc .so it is necessary to consider sunk cost in replacement analysis.