Question

You invested $1M to enter bottle distribution industry. $0.1M is spent on buying the land in the Delaware valley area, $0.8M on building a bottling factory and installing production lines, and the remaining $0.1M on raw materials procurement. Should you decide to exit, the land can be easily re-sold at original price. Due to little demand for bottling facilities, the factory has to be converted for alternative use and can be resold at $0.5M (conversion cost accounted for). The procured raw materials can be resold at a discounted price of $0.05M. What is the sunk cost of entering bottle distribution business? Keep two digits after decimal point, don't type any units.

Answer 1

Sunk cost is the cost that can't be retrieved. Such costs are already been incurred and can not be recovered.

In the above question, 1 million has been spent to enter the industry and can not be recovered. So it is sunk cost.

The land purchased can be re-sold, so land cost is not sunk cost.

The amount spent on building bottling factory and installing production lines can be recovered (although at loss), so they are not treated as sunk costs.

Similarly raw materials can be resold (although at discounted price), so raw materials cost is also not sunk cost.

The only sunk cost is the cost to enter i.e $1M.