BMFG 4623

Engineering Economy
and Management
Breakeven and Payback Analysis
References:
1. Blank, L and Tarquin, A. Engineering Economy,8thEdition,McGraw Hill, 2017.
2. Sullivan, W.G., Wicks,E.M., and Koelling,C.P., Engineering Economy,17th Edition, Pearson,
2018
3. Park C.S., Contemporary Engineering Economics, Pearson, 5th Edition, 2011

Nor Akramin Mohamad

Faculty of Manufacturing Engineering
Universiti Teknikal Malaysia Melaka
 LEARNING OUTCOMES
1.Determine the breakeven point for one parameter.
2.Analyse the breakeven point of a parameter and use it to select
between two alternatives.
3.Determine the payback period of a project at i = 0%

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 Breakeven Point
Value of a parameter that makes two elements equal
The parameter (or variable) can be an amount of
revenue, cost, supply, demand, etc. for one project or
between two alternatives
q One project - Breakeven point is identified as QBE. Determined
using linear or non-linear math relations for revenue and cost
q Between two alternatives - Determine one of the parameters
P, A, F, i, or n with others constant
Solution is by one of three methods:
Ø Direct solution of relations
Ø Trial and error
Ø Spreadsheet functions or tools (Goal Seek or
Solver)
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 Cost-Revenue Model ― One Project
Quantity, Q — An amount of the variable in
question, e.g., units/year, hours/month
Breakeven value is QBE

Fixed cost, FC — Costs not directly dependent on the variable, e.g.,

buildings, fixed overhead, insurance, minimum workforce cost
Variable cost, VC — Costs that change with parameters such as
production level and workforce size. These are labor, material
and marketing costs. Variable cost per unit is v
Total cost, TC — Sum of fixed and variable costs, TC = FC + VC

Revenue, R — Amount is Profit, P — Amount of

dependent on quantity sold revenue remaining after costs
Revenue per unit is r P = R – TC = R – (FC+VC)
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Revenue and Cost Relations

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 Breakeven for linear R and TC
Set R = TC and solve for Q = QBE
R = TC
rQ = FC + vQ

FC
QBE =
r–v

When variable
cost, v, is lowered,
QBE decreases
(moves to left)

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Example: One Project Breakeven Point
A plant produces 15,000 units/month. Find breakeven level if
FC = $75,000 /month, revenue is $8/unit and variable cost is
$2.50/unit. Determine expected monthly profit or loss.

Solution: Find QBE and compare to 15,000; calculate Profit

QBE = 75,000 / (8.00-2.50) = 13,636 units/month

Production level is above breakeven Profit

Profit = R – (FC + VC)
= rQ – (FC + vQ) = (r-v)Q – FC
= (8.00 – 2.50)(15,000) – 75,000
= $ 7500/month

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 Example: One Project Breakeven Point
FKP is manufacturing noise level meter for measuring noise level in any
environments condition. The fixed costs associated with manufacturing are RM
500,000 per year. If a base unit sells for RM 1500 and its variable cost is RM 500.
a) Determine numbers of units must be sold each year for breakeven
b) Analyse the profit for sales of 1200 units per year.
Solution:
(a) Find QBE
QBE = 500,000 / (1500-500) = 500 units/year
(b)
Profit = R – (FC + VC)
= rQ – (FC + vQ) = (r-v)Q – FC
= (1500 – 500) (1,200) – 500,000
= RM 700 000 per year

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Example: One Project Breakeven Point

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 Example: One Project Breakeven Point
(a) Determine the breakeven number of units in $1000 units

• Figure shows plot of R and TC lines.

• The breakeven value is 60 damper units.
• The increased production level of 72 units is
above the breakeven value

Figure: Breakeven Graph 13-6

Example: One Project Breakeven Point

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 Breakeven Between Two Alternatives
To determine value of common variable between 2 alternatives, do the
following:
1. Define the common variable
2. Develop equivalence PW, AW or FW relations as function of common
variable for each alternative
3. Equate the relations; solve for variable. This is breakeven value

Selection of alternative is based on

anticipated value of common variable:

ü Value BELOW breakeven;

select higher variable cost

ü Value ABOVE breakeven;

select lower variable cost

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 Example: Two Alternative Breakeven Analysis
Perform a make/buy analysis where the
common variable is X, the number of units
produced each year. AW relations are: Breakeven
AW, 1000 value of X
$/year
AWmake = -18,000(A/P,15%,6)
8 AWbuy
+2,000(A/F,15%,6) – 0.4X
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AWmake
AWbuy = -1.5X 6

Solution: Equate AW relations, solve for X 5

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-1.5X = -4528 - 0.4X
3
X = 4116 per year
2

1
If anticipated production > 4116, 0
select make alternative (lower variable cost) 1 2 3 4 5
X, 1000 units per year

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Example: Two Alternative Breakeven Analysis

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Example: Two Alternative Breakeven Analysis

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 Example: Two Alternative Breakeven Analysis
A consulting engineer is considering two methods for lining ponds used for evaporating
concentrate generated during reverse osmosis treatment of brackish groundwater for
the Ayer Keroh Industrial Park. A geosynthetic bentonite clay liner (GCL) will cost RM
1.8 million to install, and if it is renovated after 4 years at a cost of RM 375,000, its life
can be extended another 2 years. Alternatively,
a high-density polyethylene (HDPE) geomembrane can be installed that will have a
useful life of 12 years.
Analyse how much money can be spent on the HDPE liner for the two methods to
break even at an interest rate of 6% per year

Solution:

1. Develop the cashflow diagram for both alternatives.

2. Equate the AW relations for the two alternatives.
AW PHDPE = AW PGCL
PHDPE (A/P, 6%, 12) = 1,800,000 (A/P,6%,6) + 375,000 (P/F,6%,4)(A/P,6%,6)
PHDPE = RM 3, 575, 231

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 Example: Two Alternative Breakeven Analysis

An irrigation canal contractor wants to determine whether he should purchase a

used Caterpillar mini excavator or a Toro powered rotary tiller for servicing
irrigation ditches in an agricultural area of Tanjung Batu, Melaka. The initial cost of
the excavator is RM26,500 with a RM9000 salvage value after 10 years. Fixed costs
for insurance, license, etc. are expected to be RM18,000 per year. The excavator
will require one operator at RM15 per hour and maintenance at RM1 per hour. In
1 hour, 0.15 mile of ditch can be prepared.
Alternatively, the contractor can purchase a tiller and hire 2 workers at RM11 per
hour each. The tiller costs RM1200 and has a useful life of 5 years with no salvage
value. Its operating cost is expected to be RM1.20 per hour, and with the tiller, the
two workers can prepare 0.04 mile of ditch in 1 hour. The contractor’s MARR is
10% per year.

Analyse with graph the number of miles of ditch per year the contractor would
have to service for the two options to break even.

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 Example: Two Alternative Breakeven Analysis
Solution:

1. Determine the variable cost:

VC excavator = (15 + 1) / 0.15 = RM 106.67 per mile
VC tiller = [2 (11) + 1.20)]/ 0.04 = RM 580 per mile

2. Determine the fixed cost (Annual Worth).

Develop cash flow diagram for both alternatives
(this will help on developing the AW equation) .

Develop AW equation (fixed cost) for both alternatives

AW excavator = -26 500 (A/P, 10%, 10) – 18 000 + 9 000 (A/F, 10%, 10)
= - RM 21 748 per year
AW tiller = -1200 (A/P, 10%, 5)
=- RM 316.56 per year

3. Equate the AW relations and let x= breakeven miles per year

-21 748 – 106.67 x = -316.56 – 580 x
X = 45.3 miles per year

4. Develop breakeven graph.

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 Payback Period Analysis
Payback period: Estimated amount of time (np) for cash inflows to recover an
initial investment (P) plus a stated return of return (i%)

Types of payback analysis: No-return and discounted payback

1. No-return payback means rate of return is ZERO (i = 0%)

2. Discounted payback considers time value of money (i > 0%)
Note: only no return payback cover in this syllabus.

Caution: Payback period analysis is a good initial screening

tool, rather than the primary method to justify a project or
select an alternative

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 Payback Period Computation
Formula to determine payback period (np)
varies with type of analysis.
NCF = Net Cash Flow per period t

Eqn. 1

Eqn. 2

Eqn. 3

Eqn. 4

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 Points to Remember About Payback Analysis
• No-return payback neglects time value of money, so no
return is expected for the investment made
• No cash flows after the payback period are considered in the
analysis. Return may be higher if these cash flows are
expected to be positive.

• Approach of payback analysis is different from PW, AW, ROR

and B/C analysis. A different alternative may be selected using
payback.
• Rely on payback as a supplemental tool; use PW or AW at the
MARR for a reliable decision
• Discounted payback (i > 0%) gives a good sense of the risk
involved

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 Example: Payback Analysis
System 1 System 2
First cost, $ 12,000 8,000
NCF, $ per year 3,000 1,000 (year 1-5)
3,000 (year 6-14)
Maximum life, years 7 14

Select system that give lower payback period using no-return

payback.

Solution: (a)
np system 1 = 12,000 / 3,000 = 4 years
np system 2 = -8,000 + 5(1,000) + 1(3,000) = 6 years

Select system 1 because have lower payback period

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 Example: Payback Analysis
Determine how long will you have to sell a product that has an
income of RM 5,000 per month and expenses of RM 1,500 per
month if your initial investment is RM 28,000 and your MARR is
0%.
Solution:
np= 28 000 /(5000 – 1500) = 8 months

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 Summary of Important Points

1. Breakeven amount is a point of indifference to accept or reject

a project
2. One project breakeven: accept if quantity is > QBE
3. Two alternative breakeven: if level > breakeven,
select lower variable cost alternative (smaller slope)
4. Payback estimates time to recover investment.
Return can be i = 0% or i > 0%.
5. Use payback as supplemental to PW or other analyses,
because np neglects cash flows after payback, and if i = 0%, it
neglects time value of money.
6. Payback is useful to sense the economic risk in a project.

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