Question

A steel mill has fixed costs of $100 per hour and variable costs of $50 per hour. What will happen to these costs if the mill closes?

A. Both fixed and variable costs will remain the same.
B. The mill will have no fixed costs or variable costs.
C. The fixed costs will decrease, but the variable costs will increase.
D. The variable costs will drop, but the fixed costs will stay the same.

Answer 1

D. The variable costs will drop, but the fixed costs will stay the same. The variable costs will essentially drop to zero because the mill will be operating for zero hours. However the fixed costs will remain the same, as the steel mill must have opened before it can close.

Answer 2

This question seems a bit illogical to me. While it makes sense what trautlein has posted, they shouldn't of made fixed costs have the same time period as variable costs.

Answer 3

I agree with IceCreamVan, the entire time I realized that some of the other answers would actually work if the question wanted you to assume one thing or another. I tried to use the most obvious assumption, but in the end that's not best worded question. Good luck!

Answer 4

By stating the fixed cost on a hourly basis it also seems to have been converted into a variable cost. In this case the answer would be B, ie no fixed cost and no variable cost.

Here the assumption is that the fixed cost (since it is stated in hourly basis) is associated with production. Hence if production stops the fixed cost will also go away. I think we are confusing the 100$ an hour to be a sunk cost which it is not in this scenario.

Answer 5

I checked another website and the answer is B. ( http://www.bbrwm.com/q20120409100931AAPsWRp.html)

What's also important, is we know what the definition is for a fixed cost as it varies from subject to subject.

"In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business."

What's confusing me is what I read in the link below:

http://books.google.com/books?id=G3IkZUr9r-8C&pg=PA272&lpg=PA272&dq=fixed+cost+same+time+period+as+variable+cost&source=bl&ots=_XQeoAQLNO&sig=yaHdmXCkUMz8WDGxS7JXYqEzf1I&hl=en&sa=X&ei=S0ShT52CMsrIsgbr-syCCA&ved=0CF8Q6AEwCA

That book suggests that a firm still has to pay its fixed costs in the short run but not variable costs. It defines a sunk cost as "a cost that has already been committed and cannot be recovered". "As a result, the firm's fixed costs are sunk in the short run..."

The question is ambiguous on the nature of the mill closing. How long has the mill been operating? Has the milled produced anything? When does it pay its fixed costs? e.g. Labour is paid after work has been done in typical situation.

Answer 6

The ambiguity over the mill closing is definitively the bone of contention. How ever I offer the following argument:

If the fixed cost was a sunk cost ie. the 100$ an hour was a sunk cost then they would have to continue paying it. How ever since it is stated in an hourly basis this leads me to believe that this was dependent and directly variable with the no of hours of production. Hence in the event of the mill closure this would cease to exist.

In such cases it is also imp to study the answer options available and make an informed guess. Management accounting is after all subjective.

Answer 7

its not B