Sunk costs are cash outlay incurred in past . They are result of past decisions and cannot be changed by future decisions.
Since they do not influence future decisions, they are irrelevant costs. Further they are unavoidable and irrecoverable historical costs. And they should simply be ignored in investment analysis.
For example,
a company has conducted a market test. The results of the market test were found to be favorable. Should the company include market test costs in the evaluation of the new product?
The answer is no. The costs of the market test have already been incurred and they are sunk costs. The decision to introduce a new product cannot affect them. They are, therefore, irrelevant to the decision of introducing a new product.
Lets take another example,
A company has set up plant for a cost of ₹200 million to manufacture ball bearings. The project proved to be bad for the company, and it started accumulating losses. Further, the total outflows to -date is ₹300 million . The company is thinking of abandoning the plant.
Some executives consider it suicidal to abandon a plant on which ₹300 million have already been spent. Others feel it equally unwise to continue with a plant, which has been incurring losses and offers no possibility of any satisfactory return on that money spent.
The argument of both groups do not make sense. The ₹300 million spent by the company is a sunk cost; therefore, it is irrelevant. It is also not correct to discard the plant since it is not earning a satisfactory on a sunken investment.
The company should take the decision to sell or not to sell the plant today in light of the future cash flows and return.
Refer: https://taxandfinanceguide.com/market-value/
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