Chapter 6

Break-Even Analysis
Prepared by:
Formula
• 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)
Variables
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.

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:
Machine B
• Annual costs:

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:

-------------------------------------------------
Total Annual Cost = 12,892 + 0.19N
Machine B
• Annual costs:

_____________________________________
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)
 
N = 29,544 parts
 
Machine B is more economical for number of parts
more than 29,544
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.)
• 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.)
End of Chapter 6