At a recent board meeting, the president and CEO got into a heated argument about whether to shut down the firm's plant in Miami. The Miami plant currently loses $60,000 monthly. The president of the firm argued that the Miami plant should continue to operate, at least until a buyer is found for the production facility. The president's argument was based on the fact that the plant's fixed costs are $68,000 per month. The CEO exploded over this point in considering the shutdown decision. Accodring to the CEO, everyone knows fixed costs don't matter.
a. Should the Miami plant be closed or continue to operate at a loss in the short run?
b. How would you explain to the incorrect party that he or she is wrong?
Take a shot, what do you think?
Hint: fixed costs matter.
a. Based on the given information, the Miami plant is currently losing $60,000 per month, while its fixed costs are $68,000 per month. Therefore, it would be more financially prudent to shut down the Miami plant in the short run, as it would reduce the monthly loss by $60,000 and prevent further financial drain.
b. To explain to the incorrect party (either the president or the CEO), you would need to clarify the importance of fixed costs in decision-making. Fixed costs are expenses that do not change regardless of the level of production or sales. In this case, the fixed costs of $68,000 per month represent ongoing expenses that the company must incur, even if the plant is not operating. These costs need to be covered by the company's revenues.
While it is true that fixed costs do not directly impact the loss of $60,000 per month, they still have financial implications. By continuing to operate the Miami plant, the company would be incurring additional variable costs (such as labor, utilities, and raw materials) which contribute to the monthly loss. Shutting down the plant would eliminate these variable costs and reduce the overall financial burden on the company.
It's important to consider the bigger picture and evaluate the overall impact on the company's financial health. In this case, closing the Miami plant would result in immediate cost savings, prevent further losses, and allow the company to focus on alternative strategies such as finding a buyer for the production facility.