Week 11: Real World Applications 10

Assume Daewook, 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 Daewook add the new capacity? Elaborate.

Place your answer here.

Considering that our cost of production is 40 dollars per barrel on labor costs, raw material, and energy. Then an additional 35 dollars per barrel when adding interest, depreciation, insurance, and administrative staff expenses, making in a total of 75 dollars per barrel.

According to Conerly (2007), a company that is capital-intensive needs to continue their operations even when the market hits a downturn. Even if Daewook’s business do not make enough to cover all their expenses, them keeping up the business will still contribute partially to their overhead. As long as Daewook adn the rest of the mines keep up their business it will also help the overall business to get out of the recession.

Like mentioned before, Daewook’s business is a capital-intensive one. According to Conerly (2007), this means that they have longer lead times for expansion. He also mentions that businesses that are capital-intensive should invest in their business when the market is strong. This potential increase in Daewwok’s business and his competitors will lead to drop in prices, because of the new increased capacity. This drop in pricing and new increased capacity could be dangerous to a lot of businesses, including Daewooks. Because of these increased costs, I would not recommend Daewook to invest during this period.