Chapter 6 – Break-Even Analysis

Engineering Economics

CHAPTER 6
BREAK-EVEN ANALYSIS

In engineering economy, many situations are encountered where the cost of two or more alternatives may be
affected by a common variable. Break-even point is the value of the variable for which the costs for the alternative
will be equal.

C1 = f1 (x) and C2 = f2 (x)

where:
C1 = certain specified total cost applicable to alternative 1
C2 = certain specified total cost applicable to alternative 2
x = a common independent variable affecting Alternative 1 and alternative 2

The break-even point is where C1 and C2 are equal,

f1 (x) = f2 (x)

which may be solved for x, the break-even point.

BREAK-EVEN CHART
Break-even chart is a graphical representation of break-even analysis. The break-even point is the quantity of
production at which the income is equal to total cost. It is the intersection of the income line and the total cost line
on the break-even chart.

When two alternatives are to be compared, the break-even point is the intersection of the total cost line for each
alternative on the break-even chart.

PROBLEM (6-1) Two machines are being considered for the production of a particular part for which there is a
long- term demand. Machine A costs 50,000 Birr and is expected to last 3 years and have a 10,000 Birr salvage
value. Machine B costs 75,000 Birr and is expected to last 6 years and have zero salvage value. Machine A can
produce a part in 18 seconds; Machine B requires only 12 seconds per part. The out-of-pocket hourly cost of
operation is 38 Birr for A and 30 Birr for B. Monthly maintenance cost are 200 Birr for A and 220 Birr for B.
If interest on invested capital is 25%, determine the number of parts per year at which the machines are
equally economical. If the expected number of parts per year is greater than this break-even quantity, which
machine would be favored?

FIRST SOLUTION:

By Algebraic Solution:
1. Let N = number of parts per year for equal costs

By the Annual Cost Method:

Machine A
Annual costs:
50,000 −10,000 40,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 𝐹 = = 10,492 𝐵𝑖𝑟𝑟
,25%,3 3.8125
𝐴
𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 200 12 = 2,400 𝐵𝑖𝑟𝑟
18
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 = 38 3,600 𝑁 = 0.19𝑁
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 50,000 0.25 = 12,500 𝐵𝑖𝑟𝑟
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = 25,392 + 0.19 𝑁

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Chapter 6 – Break-Even Analysis
Engineering Economics

Machine B
Annual costs:
75,000 75,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 𝐹 = = 6,661 𝐵𝑖𝑟𝑟
,25%,3 11.2588
𝐴
𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 220 12 = 2,640 𝐵𝑖𝑟𝑟
12
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 = 30 3,600 𝑁 = 0.10 𝑁
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 75,000 0.25 = 18,750 𝐵𝑖𝑟𝑟
Total Annual Cost = 28,051 + 0.10N

2. Equate the annual cost of A and B

25,392 + 0.19N = 28,051 + 0.10N

N = 29,544 parts
Machine B will be more economical for number of parts more than 29,544

SECOND SOLUTION:

By the Rate of Return On Additional Investment Method:

1. Let N = number of parts per year for equal costs
Machine A
Annual costs:
50,000 −10,000 40,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 𝐹 = 3.8125 = 10,492 𝐵𝑖𝑟𝑟
,25%,3
𝐴
𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 200 12 = 2,400 𝐵𝑖𝑟𝑟
18
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 = 38 3,600 𝑁 = 0.19𝑁
---------------------------------------------------------------
Total Annual Cost = 12,892 + 0.19N

Machine B
Annual costs:

75,000 75,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = = = 6,661 𝐵𝑖𝑟𝑟
𝐹 11.2588
𝐴 , 25%, 3
𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 220 12 = 2,640 𝐵𝑖𝑟𝑟
12
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 = 30 𝑁 = 0.10 𝑁
3,600
________________________________________
Total Annual Cost = 9,301 + 0.10N

2. Compute Annual savings

Annual savings on Machine B = (12,892 + 0.19N) – (9,301 + 0.10N) = 3,591 + 0.09N

3. Compute Additional Investment on Machine B = 75,000-50,000

= 25,000 Birr

4. Compute for N using the formula of Rate of Return on Additional Investment, (RROAI= 0.25)

3,591+0.09 𝑁
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 25,000
= 0.25 N = 29,544 parts

Machine B is more economical for number of parts more than 29,544

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Chapter 6 – Break-Even Analysis
Engineering Economics

PROBLEM (6-2) A local factory assembling calculators produces 400 units per month and sells them at 1800 Birr
each. Dividends are 8% on 8,000 shares with par value of 250 Birr each. The fixed operating cost per month is
25,000 Birr, other cost are 1,000 Birr per unit. Determine the break-even point. If only 200 units were produced
per month, determine the profit or loss.

SOLUTION:
1. Let x = the number of calculators per month to break-even

Income = 1,800 Birr per unit

Fixed costs = 25,000 Birr per month
Variable costs = 1,000 per unit
Dividend = 8% per year

2. Income = Total cost

1,800x = 25,000 + 1,000x

X= 31.25 say 32 units (Ans.)

3. For 200 units produced.

a. Dividend = [ (250)(0.08)(8000)/12] = 13,333 Birr per month

b. Income = Total Cost + Dividend + profit or loss

(1,800)(200) = 25,000 + (1,000)(200) + 13,333 + Profit/Loss

Profit = 121,667 Birr per month (Ans.)

PROBLEM (6-3) A company manufacturing cements has a capacity of 2000 bags a month. The variable costs are
150 Birr per bag. The average selling price of the bags of cement is 300 Birr. Fixed costs of the company amount to
150,000 Birr per month, which include all taxes. The company pays an annual dividend of 12 Birr per share on each
30,000 shares of common stocks.
a. Determine the number of bags of cement that must be sold each month to break-even.
b. What is the profit or loss if 1200 bags were produced and sold a month?

SOLUTION:
1. Let x = the number of bags of cement per month to break-even

Income = 300 Birr per bag

Fixed costs = 150,000 Birr per month
Variable costs = 150 per bag
Dividend = 8% per share per year

2. Income = Total cost

300x = 150,000 + 150x

X= 1,000 bags (Ans.)

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Chapter 6 – Break-Even Analysis
Engineering Economics

3. For 1200 bags of cement produced.

a. Dividend = [ (12) (30,000)/12] = 30,000 Birr per month

b. Income = Total Cost + Dividend + profit or loss

(300)(1,200) = 150,000 + (150)(1200) + 30,000 + Profit/Loss

Profit = 0 (Ans.)