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Forced To Shut Your Doors

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Forced to Shut Your Door

When a corporation has begun to take a loss they may consider closing down all operations. While this would be the easy way out, many firms continue to operate during such hard times. There are several steps that can be taken to restore the business "out of the red", such as bankruptcy, restructuring and negotiating with their creditors.

The Firm's Shut-Down Decision

The decision to shut-down is a short-run decision, a day-to-day decision to temporarily halt production in response to market conditions (O'Sullivan and Sheffrin, 2006). The firm's objective is to maximize its economic profit, which equals its total revenue minus its total cost, where "cost" refers to economic cost (O'Sullivan and Sheffrin, 2006). Using the marginal principle, the typical firm will maximize profit where the market price equals the firm's marginal cost. The shut-down price is the price at which the firm is indifferent between operating and shutting down (O'Sullivan and Sheffrin, 2006). The firm should continue to operate if revenue exceeds the average variable cost, otherwise it should shutdown.

Shut-Down Rule

The shut-down rule states that if a company's total variable cost exceeds its total revenue then the company should shut down. However, if the total revenue exceeds the total variable cost then it should continue operating.

Shutdown if TVC>TR

Operate if TR>TVC

Calculations

We will first have to find this company's total variable cost, which is derived by multiplying its amount of workers by their wages.

70,000 X $100.00 = $7,000,000.00 = Total Variable Cost

Then to find the company's total revenue we will multiply the price per unit by the quantity sold.

$30.00 X 30,000 = $9,000,000.00 = Total Revenue

Now remember the rule. In this case the total revenue exceeds the total variable cost and thus the firm should continue to operate. But even after taking into consideration the shut-down rule, the ultimate decision will based upon the Intuition Rule. How does the market's future look? Can you recover cost by other means? Have any arrangements been made with your creditors?

In today's news, Wendy's announced that on March 2, 2007 it will be closing its first opened restaurant. Wendy's, a nationally known hamburger restaurant has been in existence for just shy of 38 years. Per David Lynch, the

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