Question

A manager attempts to persuade her bank to provide additional funding for continuing the development of a new product by arguing that: ‘It would be foolish to abandon a project on which nearly £100 million has already been spent.’ Do you support this argument? Briefly explain

Answer 1

No, I do not support this argument because the cost which have already been incurred is a kind of sunk cost and it is never taken into consideration for any kind of decision making related to acceptance and rejection of a project.

Sunk cost are those cost which are irrelevant in nature and which are not considered for decision making as they do not have any effect on acceptance or rejection of projects.

Bank has to look at decision related to approval of loan by not considering the cost already incurred, but looking for the future prospect of the project as it is what will be considered in capital budgeting decision of the company.

When a project is not able to generate profits and it is not able to repay with the previous debt repayment schedule, then the banks should decide against approval of any loan because the project is not profitable in nature and it is not generating enough return in order to fulfill the the payment obligation associated with loan which will be approved by the bank.

The persuasion of manager to her Bank for providing additional funding is not having an adequate reason because the cost which have already been incurred is a kind of sunk cost and it is completely irrelevant for new decision making so the banks should not consider the cost which have already been incurred, it should rather be considering prospective cost not retrospective cost as they have already been labelled as sunk cost.