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 I were Daewoo I would keep running the mine with the market price of crude oil falling to $50 per barrel. While the profits would take a hit, it’s better than completely shutting down all operations. Making some profit is better than no profit, most of the time. When it comes to Daewoo possibly adding an expansion due to the Russia and Ukrainian war I would say they should go for it. If the competitors are announcing expansion plans that it would be smart for Daewoo to stay in contention with the others. You don’t want your competitors to have a leg up on you when it comes to profitability.