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.

Place your answer here.

For the first question Daewook should stop running the mine. It costs too much to run the mine and pay for all the expenses that this incur. Instead of completely stopping our sales of oil barrels the barrels which have not been sold yet we can be selling and this will cover our excess expenses outside of just running the mine. In all this dpends how much reserve oil we initially have during the downturn, the risk of continuing running the mine is shutting down completely as we aren’t able to handle both the expenses of the mine and expenses outside of the mine.

For the second question as a company the sartest decision would be to expand with our competitors. Aletrnatively to approaching countries in the areas they are vying for we should expand i nto new places and continue to satisfy our current buyers, if we find a way. Also we should find a way to lower prices to the price which is lower than our competitors while also making a profit we may be able to steal their current customers. If we decide not to expand we should make a significant profit because we will pay less for buying new things, but we risk that the competitor takes our customer caused by them providing more oil than we will in the long term.