Aswath Damodaran 205
Sunk Costs
! Any expenditure that has already been incurred, and cannot be recovered
(even if a project is rejected) is called a sunk cost
! When analyzing a project, sunk costs should not be considered since they are
incremental
! By this definition, market testing expenses and R&D expenses are both likely
to be sunk costs before the projects that are based upon them are analyzed. If
sunk costs are not considered in project analysis, how can a firm ensure that
these costs are covered?
Sunk costs should not be considered an investment analysis, but a healthy firm
has to figure out a way to recover sunk costs from on-going projects. The only
way to ensure that this happens is to have a process where costs are examined
before they become sunk. For instance, pharmaceutical firms need to be able to
ask whether a specified expenditure in R&D is worth it (given expectations for
products that might emerge from the R&D, and the size of the market) before
the expenditure is made.
This is likely to be far more difficult if the research is basic research without a
specific product in mind.
