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. Although Daewoo may be susceptible to large profit losses during a recession, they should not shut down their mine. In a capital intensive industry you should always run your business when your price exceeds costs. They still are making money in overhead as opposed to completely shutting down their business which would turn their profits to $0. Daewoo should continue running their business.

Daewoo should add the new capacity as the demand for global oil will probably remain high, and wartime will only add uncertainty to the global oil trade. They must keep up with their competitors new capacity. Daewoo must make sure expansion is within their means, but if it is expansion would probably be the right move in this scenario.