# Break-Even Analysis

Greg Hiatt May 5, 2002

Defined:
Break-even analysis examines the cost tradeoffs associated with demand volume.

Overview:
• • • •

Break-Even Analysis
Benefits Defining Page Getting Started Break-even Analysis – Break-even point – Comparing variables • Algebraic Approach • Graphical Approach

Benefits and Uses:
• The evaluation to determine necessary levels of service or production to avoid loss. • Comparing different variables to determine best case scenario.

Defining Page:
• USP • UVC • FC • Q = Unit Selling Price = Unit Variable costs = Fixed Costs = Quantity of output units sold (and manufactured)

Defining Page:
Cont.
• OI • TR • TC • USP = Operating Income = Total Revenue = Total Cost = Unit Selling Price

Getting Started:
• Determination of which equation method to use: – Basic equation – Contribution margin equation – Graphical display

Break-even analysis:
Break-even point
• John sells a product for \$10 and it cost \$5 to produce (UVC) and has fixed cost (FC) of \$25,000 per year • How much will he need to sell to break-even? • How much will he need to sell to make \$1000?

Algebraic approach:
Basic equation
Revenues – Variable cost – Fixed cost = OI

(USP x Q) – (UVC x Q) – FC = OI \$10Q - \$5Q – \$25,000 = \$ 0.00 \$5Q = \$25,000 Q = 5,000

What quantity demand will earn \$1,000? \$10Q - \$5Q - \$25,000 = \$ 1,000 \$5Q = \$26,000 Q = 5,200

Algebraic approach:
(USP – UVC) x Q = FC + OI Q = FC + OI UMC Q = \$25,000 + 0 \$5 Q = 5,000

Contribution Margin equation

What quantity needs sold to make \$1,000?

Q = \$25,000 + \$1,000 \$5 Q = 5,200

Graphical analysis:
Doll ars 70,000 Total Cost 60,000 Line 50,000 40,000 30,000 20,000 Total Revenue 10,000 Break-even point Line 0 1000 2000 3000 4000 5000 6000 Quantity

Graphical analysis:
Cont.
Dol lars 70,000 Total Cost 60,000 Line 50,000 40,000 30,000 20,000 Total Revenue 10,000 Break-even point Line 0 1000 2000 3000 4000 5000 6000 Quantity

Scenario 1:

Break-even Analysis Simplified
• When total revenue is equal to total cost the process is at the break-even point. TC = TR

Break-even Analysis:

Comparing different variables

• Company XYZ has to choose between two machines to purchase. The selling price is \$10 per unit. • Machine A: annual cost of \$3000 with per unit cost (VC) of \$5. • Machine B: annual cost of \$8000 with per unit cost (VC) of \$2.

Break-even analysis:
• Determine break-even point for Machine A and Machine B. • Where: V = FC SP - VC

Comparative analysis Part 1

Break-even analysis:
Part 1, Cont.
Machine A:

Machine B:

v = \$3,000 \$10 - \$5 = 600 units v = \$8,000 \$10 - \$2 = 1000 units

Part 1: Comparison
• Compare the two results to determine minimum quantity sold. • Part 1 shows: – 600 units are the minimum. – Demand of 600 you would choose Machine A.

Part 2: Comparison
Finding point of indifference between Machine A and Machine B will give the quantity demand required to select Machine B over Machine A. Machine A FC + VC \$3,000 + \$5 Q \$3Q Q = = = = = Machine B FC + VC \$8,000 + \$2Q \$5,000 1667

Part 2: Comparison
Cont.
• Knowing the point of indifference we will choose: • Machine A when quantity demanded is between 600 and 1667. • Machine B when quantity demanded exceeds 1667.

Part 2: Comparison
Graphically displayed
Doll ars 21,000 18,000 Machine A 15,000 12,000 9,000 Machine B 6,000 3,000 0 500 1000 1500 2000 2500 3000 Quantity

Part 2: Comparison

Graphically displayed Cont.
Doll ars 21,000 18,000 Machine A 15,000 12,000 9,000 Machine B 6,000 3,000 Point of indifference 0 500 1000 1500 2000 2500 3000 Quantity

Exercise 1:
• Company ABC sell widgets for \$30 a unit. • Their fixed cost is\$100,000 • Their variable cost is \$10 per unit. • What is the break-even point using the basic algebraic approach?

Exercise 1:
Revenues – Variable cost - Fixed cost = OI

(USP x Q) – (UVC x Q) – FC \$30Q - \$10Q – \$100,00 \$20Q Q

= OI = \$ 0.00 = \$100,000 = 5,000

Exercise 2:
• Company DEF has a choice of two machines to purchase. They both make the same product which sells for \$10. • Machine A has FC of \$5,000 and a per unit cost of \$5. • Machine B has FC of \$15,000 and a per unit cost of \$1. • Under what conditions would you select Machine A?

Exercise 2:
Step 1: Break-even analysis on both options. Machine A: v = \$5,000 \$10 - \$5 = 1000 units Machine B: v = \$15,000 \$10 - \$1 = 1667 units

Exercise 2: