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?
a. Should the Miami plant be closed or continue to operate at a loss in the short run? The Miami plant should not be closed.
b. How would you explain to the incorrect party that he or she is wrong? The $68,000 in fixed costs will still exist until the plant is sold, if they shut down and do not produce anything the plant may lose $68,000 a month instead of $60,000.
a. Whether the Miami plant should be closed or continue to operate at a loss in the short run depends on several factors. One of the key considerations is the presence of potential buyers for the production facility. If there are potential buyers who are interested in acquiring the plant, it might be financially prudent to continue operating the Miami plant until a buyer is found. By keeping the plant operational, there is a chance of recovering some of the fixed costs through a sale.
Another factor to consider is the overall financial health and stability of the company. If the losses from the Miami plant are significantly impacting the company's bottom line and causing financial strain, it might be necessary to shut down the plant to minimize losses and ensure the long-term viability of the company.
b. To explain to the CEO that his viewpoint is incorrect, you can provide an explanation of fixed costs and their relevance in decision-making.
Fixed costs are expenses that do not vary with the level of production or sales. They are incurred regardless of whether the company is operating at full capacity or not. Examples of fixed costs include rent, salaries, and depreciation.
While it is true that fixed costs do not directly impact the profitability of individual units or products, they are still crucial in determining the overall financial health of the company. Fixed costs need to be covered by the revenues generated by the company as a whole. If the plant in Miami is shut down, the fixed costs associated with it will still need to be covered from other revenue sources.
By continuing to operate the plant at a loss, the company can contribute towards covering its fixed costs. However, it's important to consider the financial implications and evaluate whether the losses incurred from the Miami plant are outweighed by potential future benefits, such as finding a buyer for the facility.
In summary, fixed costs are a relevant consideration in decision-making as they need to be covered by the overall revenue generated by the company. Shutting down the Miami plant without assessing the potential impact on fixed costs could have long-term implications for the financial health of the company.