Question

"Sunk costs are never relevant in decision making." Yet, the world and our personal lives are full of examples where sunk costs heavily affected our choices. Share with the class some examples you’ve found in your research or your personal experiences of allowing sunk costs to influence decisions. How can we prevent this bias in the future?

Answer 1

Sunk costs:

A sunk cost is a cost that has already been incurred and thus cannot be recovered

1.A sunk cost differs from future costs that a business may face, such as decisions about inventory purchase costs or product pricing

2.Sunk costs (past costs) are excluded from future business decisions, because the cost will be the same regardless of the outcome of a decision.

we can discuss it with an example

For example, suppose a business executive of a finance consulting company is hired to build a financial analytics application and will receive $10 million at the end of the project. The business executive determines it will cost $7 million in total to finish the project and take one year. The company will profit $3 million for completing this project

However, in the ninth month of operation, her team runs into problems with the main framework of the application. The firm already spent $5.25 million on this project, and the business executive must decide whether to continue with the project or cancel it. She estimates that this major setback will cost an extra $1 million. However, the company can still profit $2 million from the project

Whether the business executive decides to continue with the project or cancel it, the costs spent for the nine months of operation cannot be retrieved. This should be irrelevant to her decision because only future costs and potential revenues should be considered. If she cancels the project, the company would incur a $5.25 million loss and have revenues of $0. If she continues with the project, the future revenue for the company is $10 million, and future costs are only $2.75 million.

sunk costs if once incurred they cannot be retrieved

you can prevent this bias by making good decisions of investment

you have to research about many things like market demand,cost of raw materials,customers for the product,market for selling those product etc,.