Legal Definitions - sunk cost

Sunk Cost

A sunk cost refers to an expense that has already been incurred and cannot be recovered. Because this money has already been spent and is irretrievable, it should not be considered when making future decisions. The principle is that rational decision-making should focus on future costs and benefits, not on past expenditures that are gone regardless of the choice made.

• Example 1: Business Investment

  A technology company invests $5 million in developing a new software application. After two years, the market for this type of software shifts dramatically, and the company realizes the application, if launched, will likely generate minimal revenue. The $5 million spent on development is a sunk cost. When deciding whether to continue investing more money to complete and launch the software, or to abandon the project entirely, the company should not factor in the initial $5 million. Instead, the decision should be based on the potential future revenue versus the additional costs required to finish and market the product.

• Example 2: Legal Dispute Fees

  A client has paid $50,000 in legal fees to their attorney over the course of a complex lawsuit. As the case progresses, new evidence emerges that significantly weakens the client's position, making a favorable outcome unlikely. The $50,000 already paid to the attorney is a sunk cost. When the client considers whether to accept a settlement offer that covers only a fraction of their initial claim, or to continue fighting the lawsuit, they should not be influenced by the desire to "get their money's worth" from the $50,000 already spent. The decision should hinge on the potential future costs of litigation (more legal fees, court costs) versus the benefits of the settlement offer, regardless of past expenses.

• Example 3: Property Development

  A real estate developer purchases a plot of land for $1 million and spends an additional $200,000 on architectural designs and initial permits for a proposed commercial building. Before construction begins, a major economic downturn occurs, causing a significant drop in demand for commercial properties in that area. The $1.2 million already spent on land, designs, and permits is a sunk cost. When the developer evaluates whether to proceed with the construction, delay it, or sell the land, they should not let the past $1.2 million influence the decision. The rational choice involves assessing the current market conditions, projected future construction costs, and potential future rental income or sale price, independent of the money already invested.