# 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.