BreakBreak-Even Analysis

Greg Hiatt May 5, 2002

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

Overview: BreakBreak-Even Analysis ‡ ‡ ‡ ‡ Benefits Defining Page Getting Started Break-even Analysis Break² Break-even point Break² Comparing variables ‡ Algebraic Approach ‡ Graphical Approach .

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

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: ² Basic equation ² Contribution margin equation ² Graphical display .

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

200 .$5Q .$5Q ² $25.000? $10Q .000 $5Q = $26.$25.Algebraic approach: Basic equation Revenues ² Variable cost ² Fixed cost = OI (USP x Q) ² (UVC x Q) ² FC = OI $10Q .000 = $ 1.000 Q = 5.000 What quantity demand will earn $1.00 $5Q = $25.000 Q = 5.000 = $ 0.

000 $5 Q = 5.000 What quantity needs sold to make $1.000 + $1.000 + 0 $5 Q = 5.Algebraic approach: Contribution Margin equation (USP ² UVC) x Q = FC + OI Q = FC + OI UMC Q = $25.200 .000? Q = $25.

Graphical analysis: Dollars 70.000 40.000 Line 50.000 Total Cost 60.000 BreakBreak-even point Line 0 1000 2000 3000 4000 5000 6000 Quantity .000 30.000 Total Revenue 10.000 20.

000 Line 50.000 BreakBreak-even point Line 0 1000 2000 3000 4000 5000 6000 Quantity .000 30.000 Total Revenue 10.Graphical analysis: Cont.000 Total Cost 60.000 20. Dollars 70.000 40.

TC = TR .Scenario 1: BreakBreak-even Analysis Simplified ‡ When total revenue is equal to total cost the process is at the break-even breakpoint.

.BreakBreak-even Analysis: Comparing different variables ‡ Company XYZ has to choose between two machines to purchase. ‡ 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. The selling price is $10 per unit.

VC .BreakBreak-even analysis: Comparative analysis Part 1 ‡ Determine break-even point for breakMachine A and Machine B. ‡ Where: V = FC SP .

000 $10 . Cont.$2 = 1000 units . Machine A: v = $3.$5 = 600 units Machine B: v = $8.BreakBreak-even analysis: Part 1.000 $10 .

Part 1: Comparison ‡ Compare the two results to determine minimum quantity sold. . ‡ Part 1 shows: ² 600 units are the minimum. ² Demand of 600 you would choose 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 Finding point of indifference between Machine A and Machine B will give the quantity demand required to select Machine B over Machine A.

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

000 0 500 1000 1500 2000 2500 3000 Quantity .000 Machine A 15.000 18.000 3.000 9.Part 2: Comparison Graphically displayed Dollars 21.000 12.000 Machine B 6.

000 Machine A 15.000 Point of indifference 0 500 1000 1500 2000 2500 3000 Quantity .000 3.000 12.000 Machine B 6.000 18. Dollars 21.000 9.Part 2: Comparison Graphically displayed Cont.

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

000 .$10Q ² $100.00 $100.Exercise 1: Answer Revenues ² Variable cost .000 5.Fixed cost = OI (USP x Q) ² (UVC x Q) ² FC $30Q .00 $20Q Q = = = = OI $ 0.

‡ Machine A has FC of $5. They both make the same product which sells for $10.000 and a per unit cost of $5. ‡ Under what conditions would you select Machine A? .000 and a per unit cost of $1. ‡ Machine B has FC of $15.Exercise 2: ‡ Company DEF has a choice of two machines to purchase.

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

000 + $1Q = $10. Machine A FC + VC $5. .000 + $5 Q $4Q Q = Machine B = FC + VC = $15.000 = 2500 ‡ Machine A should be purchased if expected demand is between 1000 and 2500 units per year.Exercise 2: Answer Cont.

‡ Use as a comparison tool for making a decision. ‡ Required quantities to avoid loss.Summary: ‡ Break-even analysis can be an Breakeffective tool in determining the cost effectiveness of a product. .

and Bernard W. 2000. Cost Account. George Foster. Pentice2000. Operations Management. Datar. . Taylor III.Bibliography: Russel. Upper Saddle River. Roberta S. NJ: PenticePentice-Hall. Upper Saddle River. 10th ed.. NJ: Pentice-Hall.. and Srikant M. Charles T. Horngren.

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