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Sunk Cost - Explained in 6 minutes

When calculating Net Present Value (NPV) you do not include costs that have already been incurred. These prior expenses are known as “sunk costs.” For many, the concept of sunk cost is difficult to understand because, of course, you did spend the money and those expenses were real. However, for NPV, one is considering a very narrow question: “What is the present value of this investment that I’m about to make?” Sunk costs are in the past - the salaries you paid your team, the materials you’ve purchased and used, and the value is captured in the data you now have on hand. There is nothing you can do to get back those funds (short of selling off company assets). So, you don’t include sunk costs when calculating NPV. This short video walks you through a couple of simple examples that show how this principle can be helpful when managing a product development program. Please take the IRI TRACK workshop on Financial Analysis for Product Development to learn more.