Example 17.1 : Sunk cost A firm has an obsolete machine that was purchased and paid for two years ago. The net book value of the machine, as shown in the accounts of the firm, prior to its becoming obsolete is $72,000. The alternatives now available to the firm are - to make a number of alterations to the machine at an estimated cost of $20,000 and then to sell it for $40,000, or - to sell it for scrap, the estimated selling price being $15,000. The net book value of $72,000 represents the original cost of purchasing the machine less the accumulated depreciation (charge for depreciation over the two year period). The original cost is the result of a past decision. It was incurred two years ago and therefore it is a sunk cost. It is irrelevant to the future decision whether they alter the machine and sell it, or sell it for scrap. The depreciation is also based on the original cost of the machine and is thus irrelevant to this future decision. The only relevant costs and benefits in this example are those related to the future ; we can analyze these as follows. Alter Scrap $ $ Future benefits Future costs Future income From the analysis of relevant costs and benefits it can be seen that the firm will be off altering the machine and selling it rather than selling it for scrap