Question

We are told that in capital Budgeting Analysis, sunk costs are irrelevant. If the firm spent resources for the asset, should it not be able to recover these costs from the project?

The IRR is very intuitive to understand. Why is it not superior to the NPV in Capital Budgeting Analysis?

Answer 1

Sunk cost is something which is already incurred, and it cannot be reversed irrespective of the decision we are going to take. We should include only those aspects in decision making, which will impact the future course of the stream of cashflows. As this cost is already incurred, sunk costs are irrelevant in decsion making.

when choosing mutually exclusive projects, NPV is the better decision taking criterion compared to IRR, because of the inherent flaws in assumptions of IRR. IRR assumes that positive cashflows can be reinvested at IRR, internal rate of return which is highly unrealistic. They can usually be invetsed at the cost of capital of the firm. In some project evaluations, it gives back multiple IRR values. Because of these issues, NPV is preferred.