Tag: Enterprise Risk Management

Austin Talk Radio Batters Metrorail

Not a real headline but the discussion was a good reminder of how to NOT make a decision to abandon a project.

Investors are notoriously emotionally involved in decisions that they have made.  It is almost impossible to divorce ourselves from the consequences of important decisions that we have made.  This is called  Loss Aversion.

When we have made a decision such as investing $65 million  in a Metrorail or $5000 in WholeFoods and watch the trains operate at a loss or our stock decline by half of its value, our loss aversion and emotions keep us from correctly considering our original investment as a sunk cost.  Sunk costs are non recoverable costs that force us to admit that we have made a bad decision.

Some decisions require that we abandon our prior investment and invest additional funds that will correct the decision.  One example is abandoning a website that is too expense to maintain but that cost $15,000 for a $1000 out of the box website that works great.

Other decisions require that we look at future operations but on a cash flow basis.  If an operation, perhaps a commuter train, is cash flowing, consideration of the original investment is irrelevant to the decision as to whether to continue or stop the train.  The relevant costs to compare with income from the project are the costs that will end if operations are ceased.

Finally, we might need to consider selling assets that we can’t afford to pay for even though we would lose our investment, especially if we can pay off any debt associated with the property.  Continuing to own an asset with operating losses due to mortagage payments that could be sold is also an example of loss aversion.