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Breakeven Analysis Part 1

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EGR 403 Capital Allocation Theory Dr. Phillip R. Rosenkrantz


Industrial & Manufacturing Engineering Department Cal Poly Pomona

EGR 403 - The Big Picture


Framework: Accounting & Breakeven Analysis Time-value of money concepts - Ch. 3, 4 Analysis methods
Ch. 5 - Present Worth Ch. 6 - Annual Worth Ch. 7, 8 - Rate of Return (incremental analysis) Ch. 9 - Benefit Cost Ratio & other techniques

Refining the analysis


Ch. 10, 11 - Depreciation & Taxes Ch. 12 - Replacement Analysis
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Introduction
Break even (BE) analysis helps engineers understand the big picture Knowing how your project or assignment affects profitability can help you sell your projects to upper management Understanding BE analysis illustrates the value of engineers to the company
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Recall from the P & L Statement


Fixed costs - do not vary (e.g., lease costs, rent, insurance) Variable costs - vary with volume of production (e.g., labor, materials, supplies, rent, etc.) Overhead can also be applied here as a variable expense or burden rate. Profit Equation Profit = Revenue - Expenses
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Breakeven Volume
Total Variable Cost (VC) is a function of volume (x) of units sold. Total VC = Variable Cost/unit * x Total Cost = Fixed Cost + Total VC Revenue is also a function of units sold: Revenue = Price/unit * x Breakeven Volume is the number of units you need to sell so that: Revenue = Total Cost
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Breakeven Volume (contd)


Find x such that: Price/unit * x = Fixed + VC/unit * x Therefore: xBE = Fixed Cost / (Price/unit - VC/unit) If actual volume is < xBE , you have a loss If actual volume is > xBE , you have a profit
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Fixed Cost
Fixed cost is the the same, regardless of volume

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Variable Cost + Fixed Cost


Total Cost goes up with volume because Variable Cost increases

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Total Revenue is based on volume and selling price/unit. Where the Revenue and Total Cost lines intersect is the Break Even (BE) Point. That volume is the BE Volume

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Profit
Above the BE point, the difference between the Revenue and Total Cost lines represents profit

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Loss
If volume is below the BE point, the difference between the lines represents a loss

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Break Even Analysis


Collect financial and cost information to determine fixed and variable costs
Fixed costs Variable cost/unit (labor, materials, overhead)

Estimate Selling Price per unit from marketing analysis and market testing Determine BE volume and compare to estimated sales If estimated sales volume is not above the BE volume, make adjustments
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