Question

Assume you are the owner of a donut shop (Dalal’s Delicious Dunkers) that is about to have its grand opening. Your total investment so far has been $50,000. Then you read in the Chicago Tribune a special health report that donuts are linked to reduced life expectancy and this report has the public scared. To open Dalal’s requires that you invest another $10,000 and then you can begin selling donuts. Which of the following do you take into account when making the decision as to whether or not to proceed with the business: the $50,000 already invested? The $10,000 you need yet to invest? The revenue from the future sale of donuts? Why or why not for each?

Answer 1

The $50000 that has been invested already is a sunk cost and should not be considered when making the decision as to whether or not to proceed with the business. That is a cost which can not be now recovered and should not affect any new decisions. The decision now only depends on the new cost that has to be incurred = $10000. This is because the firm can save this $10000 if it decides to not go ahead with the business and should go ahead only if the expected benefits exceed $10000. The revenue from future sales is also needs to be taken into account as if the revenue is less than the additional $10000 that need to be paid, the business should not be started.