Question

discuss sunk and opportunity costs, why must managers consider these things

Answer 1

Costs can be classified as differential cost, sunk and opportunity costs. A sunk cost is a cost that have already incurred thus cannot be changed or recovered. These costs need not be reflected in the incremental cash flows used for estimation of internal rate of return and net present value, and should be irrelevant in the decision-making process. A sunk cost is a categorised as a irrelevant cost. While facing a potential investment or project, a manager need to only consider relevant costs and ignore all irrelevant costs. But several managers continue investing in projects because of the sheer size of the amounts already invested in the past.

Opportunity costs refer to the loss of other alternatives when one alternative is chosen over another. These costs do not necessarily involve any cash outflows however are required to be considered because they shows the foregone profit that could have been elsewhere