Examples of the Sunk Cost Fallacy
Later on, you find a better snowboard trip at Cypress Mountain that costs $100 and you purchase that ticket as well. Unknowingly, you find out that the two dates clash and you are unable to get a refund on the tickets. Would you attend the $200 good snowboard trip or the $100 great snowboard trip? A majority of people would choose the more expensive trip because, although it may not be more fun, the loss seems greater. The sunk cost fallacy prevents you from realizing what the best choice is and makes you place greater emphasis on the loss of unrecoverable money.
in Excel to remove any emotion (related to sunk costs) and look at whatever decision maximizes the Net Present Value going forward. Financial modeling is performed in Excel to forecast a company’s financial performance. Overview of what is financial modeling, how & why to build a model.
Examples of Sunk Costs
Only relevant costs (costs that relate to a specific decision and will change depending on that decision) should be considered when making such decisions. The level of investor influence a company holds in an investment transaction determines the method of accounting for said private investment. The accounting for the investment varies with the level of control the investor possesses. This guide and overview of investment methods outlines they main ways investors try to make money and manage risk in capital markets.
The company should not continue with the product launch and the initial marketing study investment should not be considered when making decisions. A company spends $10,000 training its employees to use a new ERP system. The software turns out to be heavily confusing and unreliable. The senior management team wants to discontinue the use of the new ERP system. The $10,000 spent to train employees is a sunk cost and should not be considered in the decision of discontinuing the new ERP system.
- The company should not continue with the product launch and the initial marketing study investment should not be considered when making decisions.
- A company spends $10 million to conduct a marketing study to determine the profitability of a new product they will launch in the marketplace.
- The study concludes that the product will be heavily unsuccessful and unprofitable.
The sunk cost fallacy arises when decision-making takes into account sunk costs. By taking into consideration sunk costs when making a decision, irrational decision making is exhibited. In the following examples, you can clearly see how sunk costs affect decision-making.
In both economics and business decision-making, sunk cost refers to costs that have already happened and cannot be recovered. Sunk costs are excluded from future decisions because the cost will be the same regardless of the outcome.
After attending 4 of the 7 sessions, Jennifer decides that the tutoring sessions hosted by the club do not help her at all. She decides to attend the remaining 3 sessions despite it being unhelpful because of the $100 entry fee. Tom decides to sit through the entire movie because he already bought a ticket. Sunk cost is also known as past cost, embedded cost, prior year cost, stranded cost, sunk capital, or retrospective cost.
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What is an example of a sunk cost?
In economics and business decision-making, a sunk cost (also known as retrospective cost) is a cost that has already been incurred and cannot be recovered. In other words, a sunk cost is a sum paid in the past that is no longer relevant to decisions about the future.
A company spends $10 million to conduct a marketing study to determine the profitability of a new product they will launch in the marketplace. The study concludes that the product will be heavily unsuccessful and unprofitable.