Could ignoring sunk costs be used to make an investment look more attractive (in terms of NPV) when it's really not? For instance, this is an example of the sunk cost fallacy from Principles of Corporate Finance (e10) that warns against including sunk costs in cashflows for NPV calculations:

For example, when Lockheed sought a federal guarantee for a bank loan to continue development of the TriStar airplane, the company and its supporters argued it would be foolish to abandon a project on which nearly $1 billion had already been spent. Some of Lockheed’s critics countered that it would be equally foolish to continue with a project that offered no prospect of a satisfactory return on that $1 billion. Both groups were guilty of the sunk-cost fallacy; the $1 billion was irrecoverable and, therefore, irrelevant.

This is my interpretation of why this is supposed to make sense:

What should have happened was that at the point of seeking the new loan, they should have evaluated the NPV anew to see if the project made sense (even though they now had existing assets as a result of the initial 1 bil. investment). So initial project counts as a failure and the new fed-loan project gets evaluated like a new project.

But if this is the case, then couldn't somebody do something like this:

  1. Start a project A, where we buy a large building for $X with no reasoned plan for getting a return (assume the firm ends up losing money the project marked as failure)
  2. Start a new project B, where we sell this building that we magically have for $X (ignoring how we got it since ignoring sunk costs, so the initial investment cost for the project is ~0 (not counting cost of setting of sales contract or whatever))
  3. From the perspective of NPV calculations, this project B may look more appealing than it really is because there is a lower initial cost (and a payout at the end) because are are forgetting/ignoring the fact that the building was bought for a non-zero amount, when really we are just cleaning up a previous mess and the NPV should be closer to ~0.

Is this thinking wrong-headed/confused? If so, could someone please clarify the concept (especially in the context of calculating NPV for investment projects)?

  • 1
    In short, you are assuming someone would start a project, and then do the NPV calculations. If you value the project beforehand, you include all costs. If you value a project after it has started, you eliminate all non-recoverable ("sunk") costs. So it may be worthwhile to continue a project, even if it turns out that it would have been better never to start it. Commented Nov 1, 2017 at 12:36

1 Answer 1


I'm not sure that you're considering all the options.

  1. Abandon A. Net profit from now $Y (sale price of building for A).
  2. Replace A with B. Net profit dependent on NPV of B's return.

So you may not subtract $X from B, but you do compare NPV(B) to $Y.

Also, remember that we're not trying to figure out the return on B. We're trying to figure out what to do next. In terms of planning, the sunk cost is irrelevant. But in terms of calculating return, A was a turkey. And to calculate the return, we would include $X in our costs for B. And for the second option, we'd subtract $X from $Y (may be negative).

Sunk costs are irrelevant to planning, but they are very relevant to retrospective analysis. Please don't confuse the two. When looking back, part of the cost for B will be that $X. But in the middle, after paying $X and before starting B, the $X is gone. You only have the building and have to make your decision based on the options you have at that moment.

You will sometimes hear $Y called the opportunity cost of B. You could sell out for $Y or you could do B. You should only do B if it is worth more than $Y.

The sunk cost fallacy would be comparing B to $X. Assuming $Y is less than $X, this would make you not do B when it is your best path forward from that moment. I.e. $Y < NPV(B) < $X means that you should do the project. You will lose money (apparently that's a foregone conclusion), but you will lose less money than if you just sold out.

You should also do B if $Y < $X < NPV(B) or $X < $Y < NPV(B). In general, you should do B any time $Y < NPV(B). The only time you should not do B is if NPV(B) < $Y. If they are exactly equal, then it doesn't matter financially whether you do B or not.

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