APPLICATION

OF
FUNCTION
Break even analysis deals with cost and revenue
aspect of the business.
• Break even of the function

• Let q is the quantity, v is the variable cost per unit of quantity,

f is the fixed cost, and p is the price per unit of quantity sold
• Variable cost = v q
• Total cost c = v q + f
• Total revenue R = p q

• Total profit associate with an output = total revenue – total

cost = p q – (v q + f) = q (p – v) - f

• At Breakeven the total revenue = total cost

• or (total revenue - total cost) = 0
• or q (p - v) – f = 0
f fixed cost
q*  
p  v selling price  variable cost
• Break even deals with cost and revenue aspect of the business.

• Break even analysis seeks to determine the output at which the

producer will breakeven or where his costs will exactly meet
his revenue.
Revenue
Y
Total cost
Breakeven point
Cost
and Variable cost
revenue

Fixed cost
X
Volume
Volume at breakeven
• Question 1

• A firm produces a single product, and it can market as many

units as it is able to produce at a price of Rs 1.75. Its plant and
equipment can produce as many as 5000 units a day. Total
fixed cost is Rs 2000 daily. Unit variable cost is Re 0.50. How
many units per day must be produced in order that the firm
breaks even?
• Solution:

• Total cost C = 0.50 q + 2000

• Revenue R = 1.75 q

f 2000
q*   1600
p  v 1.75  0.50

• Firm should produce 1600 units per day to break even which
is considerably less than the capacity of 5000 units per day.
Question 2:

• Gram Soaps Company is interested in determining the break-

even production of their new Janata toilet soap. It would cost
Rs 20000 for advertising, promotion and other expenses in
connection with the introducing of the new product. Variable
cost for one soap is 65 paisa and the selling price is Re 1.
Determine the break-even production.
Solution:

• Let q be the quantity of output

• Fixed cost = advertisement +production + other expenses
= Rs 20000
• Variable cost = Rs. 0.65
• Selling price = Re 1
• Total cost = Fixed cost + Variable cost = 20000 + 0.65 q
• Revenue = 1 q = q
• At breakeven, Revenue = total cost
• q = 20000 + 0.65 q or q = 57142.85
• The breakeven production is 57143
• Question 3. North-South Airline is a new low cost airline, which is planning
to introduce regular scheduled flights in India. It has already worked out a
sector wise schedule and is contemplating taking two C-848 planes on wet
lease from a Central Asian, former Soviet Republic. It is estimated that the
lease cost, along with other fixed costs like the salaries of the staff, airport
charges, administrative cost, advertising and publicity would be about Rs
36.5 crore (Rs 365 million) per annum for the whole operation. Fuel cost is
about Rs 80 per km and the cost on food and other passenger services is
estimated to be about Rs 0.08 per passenger km. Each plane is expected to fly
about 9000 km everyday and the wet lease assures aircraft availability of
close to 100%. In other words, the two planes are expected to be available all
the 365 days in a year. Each plane has seats for 126 passengers. If North-
South wishes to be competitive on price as well as on service, it cannot
charge more than Rs 1.80 per passenger km on an average.
– On an average how many seats will have to be filled in each flight for the
airline to break even?
– At what fraction capacity utilization will North-South break even?
– If these estimates are correct, how profitable is this business likely to be
at full capacity utilization?
Solution:

• Let X be the number of passenger km per annum

• Total Annual Cost is

• TC = 365 x 106 + (2 x 9000 x 80 x 365) + 0.08 X
= 365 x 106 + 525.6 x 106 + 0.08 X
= 890.6 x 106 + 0.08 X

• The total revenue is TR = 1.8 X

• At break even point TC = TR

• 890.6 x 106 + 0.08 X = 1.8 X

890.6 6 890.6 6
million passenger km
X 10  10 517.79
1.8  0.08 1.72
Solution:

(a) At break-even point, the average number of seat will have to be

filled in each flight
517790000
78.81
2 x9000 x365
(b) So the maximum number of passenger km per annum is
• = 2 x 9000 x 126 x 365 = 827.82 million passenger km

• At break even point, fraction capacity utilization is

517.72 million passenger km

100 62.55%
827.82 millon passenger km
(c) At full capacity utilization, profit will be

• =TRfullcapacity - TCfullcapacity

• = (1.80 x 827.82 x 106) – (890.6 x 106 + 0.08 x 827.82 x 106)

• = (1490.076 x 106) – (890.6 x 106) – (66.2256 x106)

• = (1490.076 – 890.6 – 66.2256) x 106

• =533.2504 x 106 = 533.25 million rupees per annum

• Question 4: ABC Company is producing a product at a variable
cost of Rs 2 per unit. The fixed cost of production is Rs 100.
However, in order to produce the same product, Chetan (Production
Manager of ABC Company) suggested two other alternative
production processes. The relevant cost figures are as shown below:

• Alternative I: Fixed cost: Rs 400

Unit variable cost: Re 1

• Alternative II: Fixed cost: Rs 225

Unit variable cost: Rs 1.50

• The objective is to minimize the total cost of production. Under

what condition any one of the alternative procedures should be
adopted?
Solution:

• There are three alternative in the production process, which are

difference in cost but products produced to be assume to be same
• Cost of production in these three alternative are given bellows, where x
is the quantity produced and
• Total cost = Fixed cost + Variable cost

• Existing Alternative a1 TC = 100 + 2 x 0 ≤ x ≤ capacity

• Alternative a2 TC = 400 + 1 x 0 ≤ x ≤ capacity
• Alternative a3 TC = 225 + 1.5 x 0 ≤ x ≤ capacity

• Objective is to minimize the production cost

• With least fixed cost a1 is least for small values of x and remain least till
the line a1 intersects a2 and a3, whichever happens first
• a1 and a2 intersect at x1 i.e. 100 + 2x = 400 + x → x1 = 300

• a1 and a3 intersects x2 i.e. 100 + 2x = 225 + 1.5 x → x2 = 250

• Hence a1 is least cost in the interval 0 < x < 250 and just above 250,
a3 is the least cost and remain so till a3 and a2 intersect.

• a3 and a2 intersects at x3, i.e. 400 + x = 225 + 1.5 → x3 = 350

• And beyond 350, a2 is the least cost.

• Hence best alternative is given in the following decision table

Interval of x Best alternative
0 ≤ x ≤ 250 a1
250 ≤ x ≤ 350 a3
350 ≤ x ≤ cap a2
 700 2x
0 + + x
10 4 00
600 = TC =
TC
500
1.5 x
400 225 +
TC =
Cost

300
200
100
0 50 100 150 200 250 300 350

Lower fixed cost = Lower intercept

• Question 5: Readwell Company is considering four
alternative processes to produce its product as given below:

• Alternative I: Alternative II
• Fixed Cost: Rs48 crore p.a. Fixed Cost: Rs80 crore p.a
• Variable Cost: Rs72000 per unit Variable Cost: Rs54000 per unit
• Capacity: 50000 units p.a. Capacity: 80000 units p.a.

• Alternative III: Alternative IV

• Fixed Cost: Rs 70 crore p.a. Fixed Cost: Rs 64 crore p.a.
• Variable Cost: Rs 66000 per unit Variable Cost: Rs 64,000 per unit
• Capacity: 70000 units p.a. Capacity: 70,000 units p.a.

• Which of the four alternatives would be the best for Readwell?

You can provide the complete Decision Table if there is no
unique best alternative in your opinion.
• (i) If x be the number of unit produced p.a.

• Then total cost for Alt I, C1 = 48 x 107 + 72000 x, 0 ≤ x ≤ 50000

• Total cost for Alt II, C2 = 80 x 107 + 54000 x, 0 ≤ x ≤ 80000

• Total cost per for Alt III, C3 = 70 x 107 + 66000 x, 0 ≤ x ≤ 70000

• Total cost per for Alt IV, C4 = 64 x 107 + 64000 x, 0 ≤ x ≤ 70000

• Comparing C3 and C4, we find that both have the same capacity
and C3 is always higher than C4 as it has higher fixed cost and a
higher variable cost per unit. Since C4 dominant over by C3, C3
can be eliminated from further analysis.
• Among C1, C2 and C4, C1 is the best when x is small and remains
the best till C1 intersects either C2 or C4, whichever happens first.

• C1 and C2 intersect at x1, where 32x10 7 units

p.a. x1  3
17777.78
18x10

• C1 and C4 intersect at x2, where 16x10 7 units

x2  20000
p.a. 8x10 3

• C1 is the least cost alternative between 0 and 17777.78 unit’s p.a.

and above this quantity C2 is better than C1

• As C2 has the minimum variable cost per unit, it remains the

least cost alternative for all higher volumes.
• This can also be verified from
7
the intersection of C 2 and C4
16x10
which occurs at x 3  3
160000 units p.a.
10x10

• Hence the decision table:

• Interval of x Best Alternative

• 0 ≤ x ≤ 17777.78 Alt I
• 17777.78 ≤ x ≤ 80000 Alt II
Question 6:

• The manufacturing process of a certain item is such that it produces

20% defective items. Fixed cost of production is Rs 1000 and
variable cost is Rs 2 per unit. The selling price is Rs 6 per unit. For
the same product an alternative procedure is available. The relevant
information for the new process is as follows:
• (j) Fixed cost Rs 2000
• (ii) Variable cost Rs 1.5 per unit
• (iii) It produces 15% defective items.
• In both the procedures the defective item can he sold again after
reprocessing for Re 0.75 per unit.
• The objective is to maximize profit.
• Under what condition should the suggestion to replace the existing
production process by the new process be accepted?
• Solution:
• Fixed cost of production = Rs. 1000
• Variable cost = Rs. 2 per unit
• Selling price = Rs. 6 per unit
• Let x be the number of unit produced
• Total cost of production of x unit = 1000 + 2x
• Total revenue = price x quantity = Rs. 6 x

• 20% of x be defective = 0.2x

• 80% of x be correct = 0.8x
• Defective items are resold after processing, processing cost is
Re 0.75 per unit.
• New total cost will be TC = 1000 + 2x + 0.75 (0.2x) = 1000 +
2.15 x
• Profit1 = Revenue - New total cost = 6x – (1000 + 2.15x) =
3.85x - 1000
• Alternative process
• Fixed cost of production = Rs. 2000
• Variable cost = Rs. 1.5 per unit
• Selling price = Rs. 6 per unit
• Let x be the number of unit produced
• 15% of x be defective = 0.15x
• 85% of x be defective = 0.85x
• Total new cost will be = 2000 + 1.5x + 0.15 × (0.75) x = 2000 +
1.5x +0.1125x = 2000 +1.6125 x
• Total revenue = Rs. 6 x
• Profit2 = Revenue - New total cost = 6x – (2000 +1.6125 x) =
4.3875x - 2000
• Objective is to maximize profit, so compare profit1 and profit2
• 3.85x – 1000 = 4.3875x – 2000
• - 0.5375 x = - 1000
• x = 1860.46 = 1860
• Interval of x Best alternative
• 0 ≤x ≤ 1860 Profit1
• 1860 ≤x ≤ cap Profit2

• Unit Profit1 Profit2

• 0 -1000 -2000
• 500 925 193.75
• 1000 2850 2387.50
• 1500 4775 4581.25
• 1860 6161 6161
• 2000 6700 6775
• Question 7. Bill' s company, Pritchett's Precious Time Pieces,
buys, sells and repairs old clock parts. Bill sells rebuilt springs
for a piece per unit of $10. The fixed cost of the equipment to
build the springs is $1000. The variable cost per unit is $5 for
spring material. Compute the Breakeven point for Pritchett’s
Precious Time Pieces. Bill Pritchett would like to determine
what price he would need to lower the Breakeven from 200 to
175 springs?
• Solution:

• Fixed cost = 1000

• Variable cost = 5
• Selling price = 10
• The number of springs sold is X and profit model become Profit =
$10X - $1000 - $5X
• If sales are 0, Bill will realize a $1000 loss.
• If sales are 1000, Bill will realize a $10 (1000) - $1000 - $5 (1000)
= $4000
• Breakeven is the number of units sold that will result in $0 profit.
• Profit = $10X - $1000 - $5X = 0
• X = 1000 / 5 = 200
• Goal Seek can be used to make necessary calculations.