Question

Waldo Mining Company currently is operating at less than 50% of practical 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 costs per month total $10,000.

Management is concerned that a further drop in sales volume will generate a loss and, accordingly, is considering the temporary suspension of operations until demand in the metals market rebounds and prices once again rise. Management has implemented a cost reduction program over the past year that has been successful in reducing costs to the point that suspension of operations appears to be the only viable alternative. Management estimates that suspension of operations would reduce fixed costs from $10,000 to $4,000 per month.

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

Answer 1

Costs are classified as Variable cost and fixed cost .Variable cost is a cost that directly varies with level of output, so if no sales are made there will be no variable cost.Fixed cost remain constant irrespective of level of output .so it continue to be incurred even if operations are temporarily shut down.

Management estimate that Fixed cost will reduce from $10000 to $4000 may be of reason that some of the fixed cost will continue to be incurred even if operations are suspended.The reason could be many such as

a)Discharge of key employees (that will reduce fixed cost) but continuance of employees for general and administrative functions.

b)Payment of property taxes will continue to be incurred even if operations are suspended.

c)Insurance cost

d)Property rent if taken on lease /rent.

so because of above cost ,fixed cost may persist at $ 4000 because this are non operational fixed cost that continue to be incurred during the suspension of operations.