To illustrate a sunk cost, let's assume that a company spent $100,000 last year to purchase and install a machine. Today, a better machine is available for $80,000 and it will reduce expenses by $50,000 in each of the next 10 years. Now the old machine can be sold for just $10,000. When deciding whether to purchase the new machine, the $100,000 that was spent on the old machine is a sunk cost.
Basically the decision is whether to spend an additional $70,000 today ($80,000 minus $10,000) in order to save $50,000 each year for 10 years. (Current and future income taxes will also be relevant.) It may be difficult, but we need to exclude sunk costs from our decisions.
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