Smoluk Mining Co. is currently operating @ less than 50% of capacity. The manage

Question

Smoluk Mining Co. is currently operating @ less than 50% of capacity. The management of the company expects sales to drop  below the present level of 10,000 tons of ore per month very soon. The sales price per ton is $3 and the variable cost per ton is $2. Fixed cost per month total $10,000.

Management is concerned that a further drop in sales volume will generate a loss and is considering the temporary suspension of operations until  demand in the metals markets reebounds and prices once again rise. Over the past year, management has implemented a cost reduction program that has been successful in reducing costs to the point that suspending operations appears to be the only viable alternative. Mangement estimates that suspending operations would reduce fixed costs by $6,000 per month.

A- Why does management estimate that the fixed costs will persist at $4,000 even though the mine is temporarily closed?

B- At what sales volume will the loss be greater or less than the shutdown cost of $4,000 per month?

C- List any qualitative factors that you think management should consider in this decision, and discuss the potential impact of each factor on the decision.

Explanation / Answer

a. Fixed costs will exist because there has to taxes, rent, interests for the loans that has to be paid even though the mine is shut down.

b.

Variable cost = 2$

Price = 3$

Fixed Cost = 10000$

Sales = x

For break even

Loss = Total cost - total Revenue = 4000

x*2 + 10000 - x*3 = 4000

x = 6000

If the sales is less than 6000 then the company will run at loss greater than the shutdown cost.

c. The management has to look after a few aspects like

Quality, Creditor effects, Reputation, Labor Relations.

If the company shuts down then the reputation will go down and hampers the labor relations dramatically. This will also effect the creditor relations and no one will be interested to invest in the future.

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