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: • • • EGR 312 - 22 Production Volume Percentage of capacity Labor rate Replacement cost Etc. 1
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. EGR 312 - 22 2
Break-Even Analysis Cost Function – cont. : Total Cost = Fixed Cost + Variable Cost presented as a function of production volume. EGR 312 - 22 3
Break-Even Analysis Breakeven Point What is the breakeven point in terms of Production volume? EGR 312 - 22 4
Break-Even Analysis Breakeven Point –cont. FC = $10, 000 VC = $5000(per 1000 units) Revenue = $8000(per 1000 units) Let Q = Production Volume (000 s) QBE = Production Volume (000 s) at the Breakeven point Total Cost = Revenue FC + VC*QBE = Revenue *QBE = ________ EGR 312 - 22 5
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? EGR 312 - 22 6
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? EGR 312 - 22 7
Break-Even Analysis In-Class Exercise EGR 312 - 22 8
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? EGR 312 - 22 9
Break-Even Analysis Breakeven analysis between two alternatives: What is the breakeven point? FC 1 = $10, 000 FC 2 = $15, 000 VC 1= $5000 / (000 s units) VC 2= $2000 / (000 s units) FC 1 + VC 1*QBE = FC 2 + VC 2*QBE _____________ QBE = ______ EGR 312 - 22 10
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 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 an annual maintenance cost of $1200. What is the breakeven point in annual production volume? Assume a MARR of 10%. EGR 312 - 22 11
Break-Even Analysis AW approach: Let x = annual production volume. AW 1 = -$10, 000 (A/P, 10%, 5) + $1000(A/F, 10%, 5) - $1000 – 1. 0 x AW 1 = ____________________ AW 1 = ____________ AW 2 = -$15, 000 (A/P, 10%, 7) + $2000(A/F, 10%, 7) - $1200 –. 8 x AW 2 = _____________________ AW 2 = ____________ x = ______ EGR 312 - 22 12
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