Sunk Costs and Opportunity Costs

A colleague argues that resources that a firm owns already should not be considered in investment analysis, because the cost is a sunk cost. Do you agree?

How would you reconcile the competing arguments of sunk and opportunity costs?

Illustration 6.8: Estimating the Opportunity Cost for a Resource with a Current Alternative Use

Working again with the Bookscape Online example, assume that the following additional information is provided:

• While Bookscape Online will employ only two full-time employees, it is estimated that the additional business associated with on-line ordering, and the administration of the service itself will add approximately 40 hours of work for the current general manager of the bookstore. As a consequence, the salary of the general manager will be increased from $ 100,000 to $ 120,000 next year; it is expected to grow 5% a year after that..

• It is also estimated that Bookscape Online will utilize an office that is currently used to store financial records. The records will be moved to a bank vault, which will cost $ 1000 a year to rent.

The opportunity cost of the addition to the general manager's workload lies in the additional salary expenditure that will be incurred as a consequence. Taking the present value of the after-tax costs (using a 40% tax rate) over the next 5 years, using the cost of capital of 22.76% estimated in illustration 5.2, yields the estimates in Table 6.6:

Table 6.6: Present Value of Additional Salary Expenses
Retirement Planning For The Golden Years

Retirement Planning For The Golden Years

If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.

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