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.

Yes, I believe Daewoo should still be running the mine even with the falls of barrel making it $50 per barrel. We will only be losing $25 dollars with the barrels at this price. If we were to stop operation we would be losing $35 a barrel, although we would not be making overhead. If competitors were to announce new expansion plans, I think it would be too late to invest. Capital intensive company goal is to add capacity before anyone else does. If Daewoo added more capital now it could put them at risk of bankrupcy.