CFA Practice Question

CFA Practice Question

"I'm losing money, but having invested so much in equipment, I simply cannot afford to shut down." If the firm is attempting to maximize profit, this decision may be ______
A. incorrect, since the firm's fixed costs are a sunk cost.
B. correct, if the firm is covering its fixed costs.
C. correct, if the firm is covering its variable costs and expects the price of its product to rise in the near future.
Explanation: A firm that is covering its variable cost (at least) should stay in business in the short run if prices are expected to rise. This is because whatever is left in terms of revenue after paying variable costs can be applied to fixed costs. If the firm goes out of business, there is nothing applied to fixed cost. Therefore, the firm is better off continuing to operate and at least applying some revenue toward fixed costs.

User Contributed Comments 7

User Comment
sireklove "A" seems correct too, although you could argue that it is less relevant to the statement than "D".
mellyg Notice the question is asking "this decision MAY be...".
option The relevant issue is whether the revenue is enough to cover cost other than the variable costs, like admin cost, which wasn't addressed. If not, A would be a better choice. So, depends on which angle you look at it, both A and C have relevant points.
julescruis All in all an easy economics section I thought
JCopeland In the short run if P<ATC at every point but MR>AVC a profit maximizing firm would produce. This will minimize losses.
pigletin fixed costs are not a sunk cost
chenyr05 Why is B wrong?
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