Question

Why don't we include sunk costs in decision making? Define relevant costs and opportunity costs and explain how they're different from sunk costs.

Answer 1

SUNK COST- A Sunk Cost is the cost that has been already incurred and cannot be recovered. This cost is independent and cannot be considered while taking decisions for making an investment. All Sunk costs are considered to be Fixed Cost but not all fixed costs are considered as a sunk cost. For example, suppose you purchased a ticket to a movie for $100 but you got an important assignment due that night then the $100 for a ticket will become Sunk Cost.

So, the sunk cost is not considered for decision making as they are not recovered by the Business.

RELEVANT COST- Relevant Cost is the cost that is incurred only when Specific decisions are to be made. It is opposite to sunk cost because it is considered while taking decisions for the investment.

OPPORTUNITY COST- It is the Benefits missed by the individual, investor or Business while choosing one alternative over another. For Example, Investment by an investor in shares over keeping amount in bank. The opportunity cost is not shown in the book of account but Business always consider it while making decisions.