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Sunk costs

A local restaurateur whose business had been profitable for many years recently purchased a liquor license, giving her a legal right to sell beer, wine and spirits at the restaurant. The license cost $75,000. While the license is transferable, only $65,000 is refundable if the owner chooses not to use it. After selling alcoholic beverages for about a year, the owner realized she was losing dinner customers and that her formerly profitable restaurant was becoming a noisy, unprofitable bar. Subsequently, she spent $6000 on advertisements in local newspapers and magazines offering to sell the license for $70,000. After a long wait, she received one offer to purchase the license for $66,000. Would you recommend she accept the $66,000 offer? Why or why not? Explain.

Solution Preview

Initial cost of the license is $75000.
If the owner chooses not to use it then the amount refundable is $65000.

After selling alcoholic beverages for a year the owner realizes that she was losing dining customers and the business was becoming unprofitable.

Cost of advertisements $6000.
Hence, total cost of the license is now $75000 + $6000 = $81000. ($75K initial fee, $6K in advertisements).

Offer price of license $70000.
The offer she got was $66000.
If she decides to sell the license she loses $81000 - ...

Solution Summary

Sunk costs are exemplified.