Break-even Analysis

Break-even Analysis
¨ To evaluate process & equipment alternatives.
¨ Objective:
¨Find the point ($ or units) at which total cost equals total
revenue, -or-
¨ Find the range of output over which different
alternatives are preferred.
¨ Assumptions:
¨ Revenue & costs are related linearly to volume.
¨ All information is known with certainty.
¨ No time value of money.

7-2
Break-even Analysis - Costs
• Fixed costs: Costs independent of the volume
of units produced.
• Depreciation, property taxes, debt, rent,
salaries, insurance, internet

• Variable costs: Costs that vary with the volume

of units produced.
• Labor, raw material, utilities based on usage,
transportation.

7-3
Break-even Chart
Total revenue line

Dollars
Profit

Total cost line

Variable cost

Loss Fixed cost

Volume (units/period)
Breakeven point
Total cost = Total revenue
7-4
Break-even Equations
F = Fixed cost per unit time.(per month, day, year, etc)
V = Variable cost per unit produced.
x = Number of units produced per unit time.
P = Revenue (price) per unit

TC = Total costs per unit time = F + Vx

TR = Total revenue per unit time = Px
Profit = TR - TC
At break-even point: Total Cost = Total Revenue

7-5
Break-Even Analysis

Total cost = fixed cost + total variable cost

TC = cf + vcv
Total revenue = volume x price
TR = vp
Profit = total revenue - total cost
Z = TR – TC = vp - (cf + vcv)

6-6
Break-Even Analysis

TR = TC
vp = cf + vcv
vp - vcv = cf
v(p - cv) = cf
cf
v = p - cv
Solving for Break-Even Volume

6-7
Break-even Example 1
A firm produces radios with a fixed cost of $7,000 per
month and a variable cost of $5 per radio. If radios sell
for $8 each:
1a) What is the break-even point?

1b) What output is needed to produce a profit of

$2,000/month?

1c) What is the profit or loss if 500 radios are produced each
week?

7-8
Break-even Example 1
A firm produces radios with a fixed cost of $7,000 per
month and a variable cost of $5 per radio. If radios sell
for $8 each:
1a) What is the break-even point?
TR = TC so 8x = 7000 + 5x
x = 7000/3 = 2,333.333 radios per month

1b) What output is needed to produce a profit of

$2,000/month?
Profit = 2000/month so
TR - TC = 8x - (7000 + 5x) = 2000
x = 9000/3 = 3,000 radios per month
7-9
Break-even Example 1 - continued
1c) What is the profit or loss if 500 radios are produced each
week?
First, get monthly production:
50052/12 = 2,166.6667 radios per month

Then calculate profit or loss

TR - TC = 82166.6667 - (7000 + 52166.6667)
= -500 $ /per month
($500 loss per month)

7-10
Break-even Example 2
A firm produces radios with a fixed cost of $7,000 per month
and a variable cost of $5 per radio for the first 3,000 radios
produced per month.
For all radios produced each month after the first 3,000 the
variable cost is $10 per radio (for added overtime and
maintenance costs). If radios sell for $8 each:
What are the break-even point(s)?

7-11
Break-even Example 2
A firm produces radios with a fixed cost of $7,000 per month and
a variable cost of $5 per radio for the first 3,000 radios
produced per month. For all radios produced each month after
the first 3,000 the variable cost is $10 per radio (for added
overtime and maintenance costs). If radios sell for $8 each:
2a) What are the break-even point(s)?
Now TC has two parts depending on the level of production:
For x  3000/month: TC = 7000 + 5x
For x > 3000/month: TC = 7000 + 5(3000) + 10(x-3000)
= -8000 + 10x
For any x: TR = 8x

7-12
Break-even Example 2 - continued
For x  3000/month: TC = 7000 + 5x
For x > 3000/month: TC = -8000 + 10x
For any x: TR = 8x

For x  3000/month: 7000 + 5x = 8x so x = 2,333.33/month

This is < 3000/month, so it is a valid break-even point.

For x > 3000/month: -8000 + 10x = 8x so x = 4000/month

This is > 3000/month, so it is also a valid break-even point.

7-13
Break-even Example 2

Dollars (Thousands)
40
Total revenue line
32

24
Total cost line

16

Break-even
8 points

1000 2000 3000 4000

Volume (units/month)
7-14
Break-even Example 3
A firm produces radios with a fixed cost of $7,000 per month
and a variable cost of $5 per radio for the first 2,000 radios
produced per month. For all radios produced each month
after the first 2,000 the variable cost is $10 per radio (for
added overtime and maintenance costs). If radios sell for $8
each:
3a) What are the break-even point(s)?

7-15
Break-even Example 3
A firm produces radios with a fixed cost of $7,000 per month and
a variable cost of $5 per radio for the first 2,000 radios
produced per month. For all radios produced each month after
the first 2,000 the variable cost is $10 per radio (for added
overtime and maintenance costs). If radios sell for $8 each:
3a) What are the break-even point(s)?
Again TC has two parts depending on the level of production:
For x  2000/month: TC = 7000 + 5x
For x > 2000/month: TC = 7000 + 5(2000) + 10(x-2000)
= -3000 + 10x
For any x: TR = 8x

7-16
Break-even Example 3 - continued
For x  2000/month: TC = 7000 + 5x
For x > 2000/month: TC = -3000 + 10x
For any x: TR = 8x

For x  2000/month: 7000 + 5x = 8x so x = 2,333.33/month

This is not < 2000/month, so it is not a break-even point!!

For x > 2000/month: -3000 + 10x = 8x so x = 1500/month

This is not > 2000/month, so it is not a break-even point!!

THERE ARE NO BREAK-EVEN POINTS!

7-17
Break-even Example 3

Dollars (Thousands)
40

32

24
Total cost line
Total revenue line
16

1000 2000 3000 4000

Volume (units/month)
7-18
 Crossover
• Used to compare different strategies or processes: each with its
unique structure of fixed and variable costs.
• Understanding the crossover point is crucial for decision-making,
when considering long-term investments or changes in operation
methods.

Crossover Point:
•This is the production level or time period at which the total costs of
the two options are equal. Beyond this point, one option becomes more
cost-effective than the other.
 Crossover Example
Imagine a company is considering two manufacturing processes:
•Process A: High fixed costs (due to expensive machinery) but low
variable costs per unit.
•Process B: Lower fixed costs but higher variable costs per unit.

• Initially, Process B may be cheaper for low production volumes due to

its lower fixed costs.
• However, as production volume increases, the lower variable costs of
Process A become more advantageous.
• The crossover point is where the total costs of both processes are the
same. Beyond this point, Process A becomes more cost-effective.
Crossover Example
Process A: FA = $5000/week VA = $10/unit
Process B: FB = $8000/week VB = $4/unit
Process C: FC = $10000/week VC = $3/unit
Over which range of output is each process best?
Crossover Example
Process A: FA = $5000/week VA = $10/unit
Process B: FB = $8000/week VB = $4/unit
Process C: FC = $10000/week VC = $3/unit
Over which range of output is each process best?
1. At x = 0 A is best (FA is smallest fixed cost).
2. As x gets larger, either B or C may become better than A:
B < A for x > 3000/6 or x > 500/week
C < A for x > 5000/7 or x > 714.28/week
so B is best for x > 500/week
3. Eventually, C will become better than B (VC< VB).
C < B for x > 2000/week
7-22
Crossover Example

Summary:
A is best for output of 0-500 units per week.
B is best for output of 500-2000 units per week.
C is best for output greater than 2000 units per week.

7-23
Practice - Summary
Process Selection with
Break-Even Analysis (cont.)

Total cost = fixed cost + total variable cost

TC = cf + vcv
Total revenue = volume x price
TR = vp
Profit = total revenue - total cost
Z = TR – TC = vp - (cf + vcv)

6-25
Process Selection with
Break-Even Analysis (cont.)

TR = TC
vp = cf + vcv
vp - vcv = cf
v(p - cv) = cf
cf
v = p - cv
Solving for Break-Even Volume

6-26
Break-Even Analysis: Example

Fixed cost = cf = $2,000

Variable cost = cv = $5 per raft
Price = p = $10 per raft

Break-even point is
cf 2000
v= = = 400 rafts
p - cv 10 - 5

6-27
Break-Even Analysis: Graph

Total
$3,000 — cost
line

$2,000 —

$1,000 —
Total
revenue
line
400 Units
Break-even point

6-28
 Process Selection
Process A has fixed cost of $2000 and variable cost of $ 5 unit.
Process B has fixed cost of $10000 and variable cost of $ 2 unit.
Which process should we select under what circumstances?

6-29
 Process Selection
Process A has fixed cost of $2000 and variable cost of $ 5 unit.
Process B has fixed cost of $10000 and variable cost of $ 2 unit.
Which process should we select under what circumstances?

Process A Process B
$2,000 + $5v = $10,000 + $2v
$3v = $8,000
v = 2,667 rafts
Below 2,667, choose A
Above 2,667, choose B
6-30
 Total cost of
$20,000 — process A

Process Total cost of

Selection: $15,000 — process B

Graph $10,000 —

Choose Choose
$5,000 — process A process B

| | | |
1000 2000 3000 4000 Units

Point of indifference = 2,667 Units

Example 4.2
6-31
Practice Problem
Process Process Process
“A” “B” “C”
Fixed $20,000 $45,000 $70,000
Cost
Cost / $10 $5 $2
Unit
Revenue $12 $12 $12
/ Unit

a) Calculate Breakeven for each process

b) Calculate Which process would you select under
what circumstances?
32