Capital Budgeting Video
Thinking about capital investment proposals
Sunk costs & Opportunity costs
Class, sunk costs & opportunity costs are important considerations when approaching a capital investment decision. Andrew touched briefly on these two concepts above, but it would be helpful to have some real world examples here. Here's an example from my workplace:
Recently in the market research department, we were reviewing available options for replacing our data processing software. In doing so, we found so many new developments in this area since we last shopped around for new software. Some of these packages were sold as SAAS (software as a service) which meant that we would download the software and pay a fee each year for updates and maintenance. There were other software providers who would let us purchase the software, then only renew if we wanted to continue with support or get updates as they were created.
We had to consider the amount of sunk cost for the software. This would be the amount that we were paying that we could never get back. We also needed to consider the opportunity costs associated with these different offerings of data processing software. For instance, some would integrate with Microsoft Office products such as PowerPoint or Excel, but only at a level that our company had not yet purchased. If we purchased another software, we would be missing out on a future opportunity to fully integrate our software and make our operations much more efficient.
What are some examples you can share with the class about sunk costs & opportunity costs for capital projects?
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