11. Explain what a sunk cost is, what an opportunity cost is, and how each cost should be handled when doing project analysis. Give an example of each type of cost.
11. Explain what a sunk cost is, what an opportunity cost is, and how each cost should be handled when doing project analysis. Give an example of each type of cost.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:11.
Explain what a sunk cost is, what an opportunity cost is, and how each cost should be
handled when doing project analysis. Give an example of each type of cost.
Expert Solution
Step 1
A sunk cost is the cost that is already incurred and is not recoverable. This type of cost is not taken into consideration, which need not be reflected in the incremental cash flows used for the estimation of net present value and internal rate of return in decision making for the business since they are irrelevant.
Opportunity cost is the benefit forgone because of not choosing an option, this type of cost analysis helps in decision making. Opportunity costs are named so because they reflect the lost opportunity to earn profit form alternative use of the funds allocated to the project under consideration.
| Sunk Cost | Opportunity Cost |
| Sunk cost is irrelevant | Opportunity cost is relevant |
| Sunk cost is not considered for decision making | Opportunity cost is considered for decision making |
| Sunk cost does not affect cash flow | Opportunity cost affect the cash flow |
| Sunk cost refers to the money already spent | Opportunity cost refers to the benefits forgone in the future |
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