Week 11: Real World Applications 10

Assume Daewoo, a hypothetical oil extraction company, has the following cost structure. It spends:

• $40/barrel on labor costs, raw materials, energy, and • $35/barrel on interest, depreciation, insurance, and administrative staff expense.

Read the textbook carefully, and answer the following questions.

• A recession hits, the market price of crude oil falls to $50 per barrel, and the profitability takes a hit. Should Daewook keep running the mine? Elaborate.
• Russia invades Ukraine, the market price shoots up well above $100 per barrel, and competitors announce new expansion plans. Should Daewoo add the new capacity? Elaborate.

If a recession hits and the market price o foil falls to 5o dollars per barrel they can still keep mining as long as the price is higher than variable costs like labor and energy. They will still contribute 10 dollars to the overhead, if they shut down the mines completely there is no way they can make money at all. As long as the price per barrel doesn’t drop below 41 dollars they should keep the mines operating. If the price per barrel shots up above 100 dollars Daewoo should still not expand operations because it takes years to do so and will have high capital costs to their company. They could possibly upgrade equipment, but expansions of new mines should not be conducted because the war may be very temporary.