The Anaconda Mining Company Currently Is Operating at Less Than

question 384

Essay

The Anaconda Mining Company currently is operating at less than 50 percent of practical capacity. The management of the company expects sales to drop below the present level of 15,000 tons of ore per month very soon. The selling price per ton of ore is $2 and the variable cost per ton is $1. Fixed costs per month total $15,000.
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 markets returns to normal levels and prices rebound. Management has implemented a cost reduction program over the past year that has been successful in reducing costs. Nevertheless, suspension of operations appears to be the only viable alternative. Management estimates that suspension of operations would reduce fixed costs from $15,000 to $5,000 per month.
Required:
a. Why does management estimate that fixed costs will persist at $5,000 per month even though the mine is temporarily closed?
b. At what sales volume should management suspend operations at the mine?

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Definitions:

Face Amount

The nominal or dollar value printed on a financial instrument, such as a bond or insurance policy.

Specified Rate

A predetermined interest rate detailed in a financial agreement or instrument.

Liquidity Risk Premium

An additional return that investors demand for holding securities with low liquidity, compensating for the cost associated with the inability to quickly sell the asset.

Corporate Bond

A corporate bond is a debt security issued by a corporation to raise funding, which promises to pay back the principal along with interest at a specified maturity date.