Problem 1: At a recent meeting, the president and the CEO of Production, Inc. go
ID: 1187297 • Letter: P
Question
Problem 1: At a recent meeting, the president and the CEO of Production, Inc. got into a heated argument about whether or not to shut down the company’s plant in Flint, Michigan. The plant currently loses $50,000/month. The president of Production, Inc. argued that the plant should continue to operate until a buyer is found for the facility. This argument was based on the fact that the plant’s fixed costs are $61,000/month. The CEO disagreed over this point, arguing that fixed costs do not matter in making the shutdown decision.
Explanation / Answer
The CEO is wrong.
By the very definition of fixed cost, it is evident that they do not depend on level of production. The company will have to pay $61000 even it does not produce anything.
Since the company is loosing $50000 per month, which is less than the fixed costs. Henc it is prudent NOT to shut the company, beacuse they will then loose $61000 instead of the $50000 that they are loosing now ( by keeping the company under operation).