Break-Even Analysis

1
Break-Even Analysis

• Break-even Analysis performed to determine the
  value of a variable that makes two elements
  equal.
• In economic terms determining a parameter such
  that revenue equals cost.
• The study parameter might be
• Production Volume
• Percentage of capacity
• Labor rate
• Replacement cost
• Etc.

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Break-Even Analysis

• Cost Function
• Fixed Cost (FC) that cost which does not vary
  based on production volume. Includes building,
  insurance, fixed overhead (e.g. Engineering
  staff), equipment recovery cost, information
  systems, etc.
• Variable Cost (VC) that cost which varies as
  production volume varies. Includes direct labor,
  materials, warranty, utilities (power
  consumption), marketing, etc.

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Break-Even Analysis

• Cost Function cont.
• Total Cost Fixed Cost Variable Cost
• Cost presented as a function of production volume.

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Break-Even Analysis

• Breakeven Point
• What is the breakeven point in terms of
  Production volume?

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Break-Even Analysis

• Breakeven Point cont.
• FC 10,000
• VC 5000(per 1000 units)
• Revenue 8000(per 1000 units)
• Let Q Production Volume (000s)
• QBE Production Volume (000s)
• at the Breakeven point
• Total Cost Revenue
• FC VCQBE Revenue QBE
• ? QBE ________________

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Break-Even Analysis

• Sensitivity Analysis
• Impact of reducing or increasing one factor
  while holding the other constant.
• Example
• What is the QBE if VC varies from 4000 to 6000?

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Break-Even Analysis

• In-Class Exercise
• You are an entrepreneur planning to enter the
  gourmet organic burger market. Your marketing
  consultant believes you can sell 150,000 burgers
  at 1.99 each.
• Fixed costs for the business are expected to
  total 140,000. In addition, variable costs will
  total about 0.97 per burger.
• How many burgers must you sell to break even?
• What if the price is 2.79? How many must you
  sell to break even?

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Break-Even Analysis

• In-Class Exercise

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Break-Even Analysis

• Breakeven analysis between two alternatives
• If demand for the product is 1,000 units a
  month, which alternative should you choose?
  3,000 units a month?

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Break-Even Analysis

• Breakeven analysis between two alternatives
• What is the breakeven point?
• FC1 10,000
• FC2 15,000
• VC1 5000 / (000s units)
• VC2 2000 / (000s units)
• FC1 VC1QBE FC2 VC2QBE
• _________________________
• QBE ____________

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Break-Even Analysis

• AW approach
• Two alternatives exist for a machining process.
  Alternative 1 has an initial cost of 10,000 and
  a salvage value of 1000 after 5 years.
  Alternative 1 also has a variable cost of 1/unit
  of product produced and an annual maintenance of
  1000.
• Alternative 2 has an initial cost of 15,000 and
  a salvage value of 2,000 after 7 years.
  Alternative 2 also has a variable cost of
  0.80/unit of product produced and an annual
  maintenance cost of 1200.
• What is the breakeven point in annual production
  volume? Assume a MARR of 10.

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Break-Even Analysis

• AW approach
• Let x annual production volume.
• AW1 -10,000 (A/P, 10,5) 1000(A/F,10,5) -
  1000 1.0x
• AW1 _______________________________________
• AW1 _______________________
• AW2 -15,000 (A/P, 10,7) 2000(A/F,10,7) -
  1200 .8x
• AW2 _________________________________________
• AW2 ________________________
• x ______