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Sunk Costs: Letting go is hard to do!

The Discussion Issue

When making decisions (investment or other), the rational thing to do is to let go of everything that has happened in the past and focus on the future. In investing, this is of course the "sunk cost principle", but it is much easier to do in theory than it is in practice.


Start by reading this piece on the sunk cost fallacy. It is fairly comprehensive and lays out in layman's terms, why sunk costs are so difficult to ignore. Follow up with this blog post I had from a few years ago on the Yankee's A Rod problem and the broader lessons for any organization that has made bad decisions in the past and feels locked in by those decisions. If you feel in the mood for more reading, there is plenty of material online on sunk costs, both in theory papers and in the popular press.

Make it personal

If you are a first-year MBA at Stern, you have made a substantial investment to be here. The tuition costs for the two years, with associated costs (and we know how quickly those mount up) amount to about $85,000/year(according to the Stern website), not counting room & board. If you moved to New York from a less expensive part of the world, your living expenses probably increased by $10,000/year and if if you are full time MBA, the opportunity cost includes the income you would have earned at your pre-MBA job, if you had stayed at it. Let's conservatively estimate that you were making $80,000/year, pre-tax, or $60,000, post-tax, at your pre-MBA job and that you would have continued to generate that income in the two years that you will be spending at Stern. Adding up these numbers, your annual cost for getting a Stern MBA is about $140,000- $150,000 post-tax dollars. (Don't get mad at me.. I am just the messenger!)

Getting an MBA is (or should be) a purely financial decision. If you are here for intellectual enrichment, I admire you for your ideals, but not for your financial sense. If you are in the MBA program, it is because you believe that getting an MBA will lead to a jump in your expected income, post-MBA. Now, let's make this story depressing, just as a hypothetical, since no one at Stern ever faces this problem. Let's assume that at this stage in the program (where you have paid one year's worth of tuition already), you realize that your expectations were unfounded and that you will have to go back to a job very similar to the one you left (making roughly the $80,000 pre-tax dollars you were making before your MBA). In other words, your MBA will make no difference to your career income potential.

Key Questions

  1. If you stay on in the MBA program for a second year, it will cost you another $150,000 next year to continue. Since you don't expect to see your annual pay to go up after the MBA, would you drop out?
  2. Does the fact that you have already spent $150,000 in the last year affecting your decision in any way? If so, how? And why?
  3. Now, let's assume that you do believe that your pay will go up after you get an MBA? How much will it have to go up on an annual basis for you to continue with the MBA program? (More specifically, will it have to go up by enough to cover two years of costs (about $300,000) or just one year?