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 Daewoo 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.
Place your answer here. 1. Daewoo should
continue running the mine. The reason for this is because while reading
the chapter we were able to get a better understanding that even if a
company is not able to cover its overhead it still is worth the time to
continue its operation which is what Daewoo should do. Since the mine is
high in its capital costs Daewoo should continue running its operations
as it won’t have a negative effect on them.
- Daewoo should not add a new capacity, the reason for this is due to
the invasion and the market price shooting up well above $100 the market
may not be strong enough to support an expansion. The reason for this is
that when one business expands, this leads to a chain reaction and other
companies follow the same path, but due to the oil prices spiking up
there will more than likely be a drop in profit which could be
detrimental to the success of Daewoo as a company overall.