sunk cost

Examples of sunk cost in the following topics:

• Sunk Costs

  • Sunk costs are retrospective costs that have already been incurred and cannot be recovered.
  • Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken .
  • The idea of sunk costs is often employed when analyzing business decisions.
  • The sunk cost is distinct from economic loss.
  • The sunk cost may be used to refer to the original cost or the expected economic loss.

• Replacement Projects

  • The net cash flows for a project take into account revenues and costs generated by the project, along with more indirect implications, such as sunk costs, opportunity costs and depreciation costs related to the project.
  • The loss of expected future cash flows from the previous project, or opportunity cost, must also be taken into account.
  • Replacement project analysis tells a company whether the costs of a replacement project provide a suitable return on investment.

• The Cost of New Common Stock

  • The cost of new common stock is determined by adding flotation costs to the cost of current equity.
  • The cost of new equity is 15.3%.
  • The cost of external equity is higher than the cost of existing equity, or retained earnings.
  • Flotation costs include all costs of issuing the securities, such as banker's fees, legal fees, underwriting fees, filing costs, etc.
  • Flotation cost of 3%.

• Information Costs and Bond Prices

  • Information costs influence the bond prices and interest rates.
  • We include these costs in the bond's market price and interest rate, and they raise the cost of borrowing.
  • Investors pay a greater cost to acquire information for the high information cost bonds.
  • Thus, investors are attracted to the low-information cost bonds, boosting their demand for low information cost bonds, increasing the market price and decreasing market interest rate.
  • Therefore, low-information-cost bonds pay a lower interest rate.

• Economic Order Quantity Technique

  • Economic order quantity is the order quantity that minimizes total inventory holding costs and ordering costs.
  • This is not the cost of goods), H = annual holding cost per unit (also known as carrying cost or storage cost) (warehouse space, refrigeration, insurance, etc., usually not related to the unit cost).
  • Total Cost = purchase cost + ordering cost + holding cost
  • Purchase cost: This is the variable cost of goods: purchase unit price × annual demand quantity.
  • Ordering cost: This is the cost of placing orders: each order has a fixed cost S, and we need to order D/Q times per year.

• Inputs to COGS

  • Cost of goods sold (COGS) refer to the inventory costs of the goods a business has sold during a particular period.
  • Costs include all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.
  • Costs of payroll taxes and employee benefits are generally included in labor costs, but may be treated as overhead costs.
  • Determining overhead costs often involves making assumptions about what costs should be associated with production activities and what costs should be associated with other activities.
  • Activity based costing attempts to allocate costs based on those factors that drive the business to incur the costs.

• The Marginal Cost of Capital

  • The marginal cost of capital is the cost needed to raise the last dollar of capital, and usually this amount increases with total capital.
  • The marginal cost of capital is calculated as being the cost of the last dollar of capital raised.
  • This happens due to the fact that marginal cost of capital generally is the weighted average of the cost of raising the last dollar of capital.
  • Since the cost of issuing extra equity seems to be higher than other costs of financing, we see an increase in marginal cost of capital as the amounts of capital raised grow higher.
  • The Marginal Cost of Capital is the cost of the last dollar of capital raised.

• Inventory Techniques

  • Average cost method is quite straightforward.
  • There are two commonly used average cost methods: Simple weighted average cost method and moving average cost method.
  • This gives a Weighted Average Cost per Unit.
  • Finally, this amount is multiplied by Weighted Average Cost per Unit to give an estimate of ending inventory cost.
  • Each time, purchase costs are added to beginning inventory cost to get Cost of Current Inventory.

• Defining Operating Leverage

  • Specifically, it is the use of fixed costs over variable costs in production.
  • For example, replacing production workers (variable cost) with robots (fixed cost) .
  • Recall that variable costs are those that change alongside the volume activity of a business, and fixed costs are those that remain constant regardless of volume.
  • These include the ratio of fixed costs to total costs, the ratio of fixed costs to variable costs, and the Degree of Operating Leverage (DOL).
  • The ratios of fixed cost to total costs and fixed costs to variable costs tell us that if the unit variable cost is constant, then as sales increase, operating leverage decreases.

• Leverage Models

  • Operating leverage models include ratios, such as fixed costs to variable costs/total costs, fixed costs to income, and the DOL.
  • The variable cost per unit is $10.
  • The total fixed costs are $1,000.
  • Just as we interpret ratios of debt to equity and debt to total assets when analyzing financial leverage, when analyzing operating leverage, we can compare fixed costs to variable costs and fixed costs to total costs.
  • Operating leverage is equal to total fixed costs divided by operating income.