Updated July 27, 2023
Definition of Sunk Cost Examples
The examples of Sunk Costs provide an idea to the user about the most common type of Sunk Costs examples present. It is impossible to give every example of the sunk cost.
Sunk costs are those whose occurrence has already taken in the past years, and the same cannot be recovered. They do not take part in the decision-making process and are irrelevant.
The following Sunk Costs Examples have been provided considering the different situations.
Examples of Sunk Cost
The following are a few examples of Sunk Costs:
Example #1
A company is planning to expand its business and wants to launch a new product on the market. It spends $ 8 million for the research, development, and study of the market to determine whether the product the company has selected will be profitable if launched in the marketplace. The research and development of the market conclude that the product if launched, will not give the profits to the company and will be heavily unsuccessful. Therefore, the cost already spent on the research and development of $ 8 million is the sunk cost. According to the study, the company should not launch a new product in the market if the product is not profitable. Also, the initial investment in research and development should not be considered while making decisions about the product launch as such cost, once spent, cannot be recovered.
Example #2
XYZ Ltd. is a manufacturing company producing and selling cricket shoes. The company took premises for the manufacturing of the product on the lease for a period of 3 years. Also, the company has installed machinery on the premises for making cricket shoes. Currently, the company is producing the basic model of cricket shoes that cost $ 40 per unit of cricket shoes and sells the same at $ 55 per unit. This gives the company a profit of $ 15 per cricket shoe ($ 55 – $40).
Recently the company came to know that is a demand for premium cricket shoes in the market. The additional cost for the production of premium cricket shoes is $ 20. So, the total cost of production is $ 60 per unit ( $ 40 + $ 20). If the company produces premium cricket shoes, they can be sold for $ 85. The total profit the company will earn if it decides to sell the premium cricket shoes comes to $ 25 ($ 85 – $60). In the case of basic cricket shoes, the company is earning a profit of $ 15 per unit, and in the case of premium cricket Shoes, the company will be earning a profit of $ 25. So, the management of the company decides to start the production of the premium cricket shoes as this company will earn an extra $ 10 per unit ($25 – $ 15).
In this case, the decision on which product to produce and sell, the rent of the building for the period of 3 years, and the machinery will be the sunk costs because the company has to incur the expenditure on lease and machinery irrespective of the decision to make either of the products. Thus these costs will not form part of the decision-making process.
Example #3
ABC Ltd. Construction Company started the development of the new housing sub-division. It purchased the initial construction materials and the other framing material costing $ 5 million. After investing this much money, suddenly, the crisis started in some of the different industries in the market, including the banking industry, causing the recession. This leads to the fallout of the housing market as well. In effect, the worth of the land purchased by the company also decreased even below the purchase price of land to the company. The company’s management is unsure about the situation and future decisions. If it abandons the project, the company will have to face a loss of $ 5 million. If it continues the construction of the project, then the company will have to incur the additional cost of $ 10 million to complete the project.
In the present case, $ 5 million is a sunk cost. This is the amount that the company will not be able to recover it. So, it should not form a part of the decision-making process. The management should make the decision as per the current banking and housing industry environment. Making the decision without considering sunk costs will let the management abandon the project as it will limit their losses to $ 5 million; otherwise, they might have to lose the additional $ 10 million if it decides to complete the project. However, the company can use the additional $ 10 million for some other project that suits the prevailing business environment better.
Conclusion – Sunk Cost Examples
The cost the entity has already incurred and cannot be recovered is known as the sunk cost. These costs should not form part of the decision-making process. The person deciding whether to continue the investment in the ongoing project should not consider the sunk cost. These costs are the cost that cannot be recovered. And instead of that one should consider only the relevant costs while making the decision. Some of the managers, however, consider the sunk costs while deciding and continuing the investments in the projects because of the amounts already invested by them and the fear of losing the money already invested. Thus, a sunk cost is the amount spent. In addition, this should not include while making the decision about further investments.
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