Chapter 13

Breakeven
And
Payback Analysis

Breakeven Analysis

eterofaprojectoralternativethatmakestwoelementsequal
vesisequallyacceptable

Payback analysis

quiredminimumlifeofasset,process,orsystemtorecoverthe
back:

eeningtoolorsupplementalinformationforPW,AW,orother

1 Breakeven Analysis for a Single Projec

theengineeringeconomysymbolsP.F,A,i,ornisnotkno
uantitycanbedeterminedbysettinganequivalencerelationfo
d,include

nbyhandifonlyonefactorpresentoronlysingleamountsareestimated
rbyhandorcalculatorwhenmultiplefactorsarepresent

eofaparameterthatmakestwoelementsequalbreakeven
ywidely:unitsperyear,costperkilogram,hourspermonth,p

Revenue and Cost Relations

(a)Revenuerelations

1)increasing
2)Decreasingrevenueperunit
Revenue
per year
R

(1) nonlinear
(2)

linear

Q units per year

Revenue and Cost Relations

(b)LinearcostRelation
TC=FC+VC

TC=totalcost
FC=fixedcost
VC=variablecost

Revenue and Cost Relations

(c) Nonlinearcostrelations

TC=FC+VC
TC
Cost
per
year

VC

FC
Q units per year

tsmaybelinearornonlinearusuallyincludetwocomponen

varyforalargerangeofproductionlevelorworkforcesize.Examp
e,andotherparameter.Example:directlabor,materials,indirectc

Relation:

TC=FC+VC

TheintersectbetweenRandTCusedtoidentifythebreakecenq

Profit=revenuetotalcost
=RTC
=R(FC+VC)

ArelationforbreakevenpointbysettingtherelationforRandT

R=TC
rQ=FC+vQ
QBE=

Where r = revenue per unit

v = variable cost per unit

FC
rv

Breakeven Point
$

R
breakeven

TC

breakeven
with
lowered VC

TC with
lowered VC
Profit maximize

loss

breakeven point
moves

Profit

QBE
Q units per year

TC
Profit
maximize

Profit range

loss

loss
QBE

QP

QBE

Example 13.1

60 diverter systems per month, but due to significantly improved economic

re with the current breakeven point?

per that is necessary to breakeven at a significantly reduced monthly produ

Solution

Useequation[13.2]todeterminethebreakevennumberofunits
QBE===60unitspermonth

) ToestimateprofitatQ=72unitspermonth,useequation[13.1]

$1000
5000 Profit
4000 -

Revenue line
Total cost line

3000 2400

QBE = 60
0

60
Q, units/month

100

Profit=RTC=rQ(FC+vQ)
=(rv)QFC
=($75$35)72$2400000
=$480,000
Thereisaprofitof$480,000permonthcurrently

hprofit=0,Q=45andFC=$2.4million.

,000,therevenueperdampermustincreasefrom$75,000to$88,33

2 Breakeven Analysis Between

Two Alternatives

nesthevalueofcommonvariableorparameterbetweentwoal
gPWorAWrelationstodeterminethebreakevenpoint
ndependsupon:
fthevariablecostcurve
etervaluerelativetothebreakevenpoint

Alt.1 TC

Total
cost

Alt.2 FC
Alt.2 TC
Breakeven
point
Alt.1 FC
Common variable, units

ebrakevenpointitiseasiertocalculateusingengineeringeconom

edwhenthevariableunitsonayearlybasis
onsimplerforalternativeswithunequallives

inethebreakevenpoint:

mmonvariableanditsdimensionalunits
WorAWrelationforeachalternativeasafunctionofthecommonvariab
orelationsandsolveforthebreakevenvalueofthevariable

Guideline

Total cost, $

owthebreakevenvalueselectalternativewiththehighervariab
ealternativewiththelowervariablecost
Alt.1 TC
Alt.2 FC
Alt.2 TC
Breakeven
point
Alt.1 FC
Common variable, units

Example 13.2

al cost of $23,000, an estimated salvage value of $4000, and a predictable

r hour each. The machine will have an annual maintenance and operation

Solution
1.Letxrepresentthenumberoftonsperyear
2.Fortheautofeedmachine,theannualvariablecostis
$121hour xtons
Hour8tonsyear
AnnualVC=
=1.5x$/year
TheAWexpressionfortheautofeedmachineis
AWauto=$23,000(A/P,10%,10)+$4000(A/F,10%,10)
$35001.5x$/year
=$69921.5x$/year

milarly,theannualvariablecostandAWforthemanualfeedmachinear
$81hourxtons
Hour6tonsyear
=4x$/year
AnnualVC=
(3operators)
AWmanual=$8000(A/P,10%,5)$15004x
=$36104 x
Equatethetwocostrelationsandsolveforx
AWauto=AWmanual
$69921.5x=$36104 x
x=1353tons/year

Thebreakevenanalysisapproachiscommonlyusedformakeorbuydecisions
Meanscompanycontractstobuytheproductorservicefromtheoutside
Ormakesitwithinthecompany
Thealternativetobuyhasnofixedcostandalargervariablecostthanmakeoption

Example 13.3

wer a wheelchair. The steel arm of the lift can be purchased for $
a life of 4 years, and have a $-500 salvage value (carry-away cos

a normal 8-hour period, the operators and two machines can p

hine A and B are as stated. The company expects to produce 10

Solution

todeterminethebreakevenpoint
enumberofliftsproducedperyear.
ablecostsfortheoperatorsandfixedcostsforthetwomachinesfor
perunit)(unitsperyear)

TheannualfixedcostsformachinesAandBaretheAWamounts.
AWA=1$8,000(A/P,15%,6)+$2000(A/F,15%,6)
$6000$3000(P/F,15%,3)(A/P,15%,6)
AWB=412,000(A/P,15%,4)$500(A/F,15%,4)$5000
TotalcostisthesumofAWA,AWB,andVC

the buy option (3.50x) and the make option yields

$2000(A/F,15%,6)
%,3)(A/P,15%,6)
500(A/F,15%,4) [13.7]

must be produced each year to justify the make option, which ha

olutionyieldsPA=$58,295.Thisisapproximatelythreetimes

Payback Analysis

Alternative 1
Alternative 2
Alternative 3

Total cost,
$/year
Breakeven
points

Output, units/hour

niques
merequiredtorecoverthefirstcostofanassetorproject
dtimefortherevenues,savingstocompletelyrecovertheinit

overyofonlytheinitialinvestment)

NCF(netcashflow)=cashinflowscashoutflows
Noreturn,i=0%;NCFvariesannually
0=P+NCFt
Noreturn,i=0%,annualuniformNCF
np=
Discounted,i>0%;NCFvaariesannually
P
0=P+NCFt(P/F,i,t)
NCF
Discounted,i>0%,annualuniformNCF
0=P+NCF(P/A,i,np)

ashflowswillrecovertheinvestmentinyear0plustherequire
usedmorethannpyears,alargerreturnresults
essthannpyears,thereisnotenoughtimetorecovertheinve
glectsallcashflowsafterthepaybackperiodofnpyears

pplementaltool.Thereasonforthiscautionare
fmoney,sincenoreturnonaninvestmentisrequired
lowsoccuringafterthepaybackperiod.Thesecashflowsm

Example 13.5

chasebySquareDElectric.Machine2isexpectedtobeversatilea

eq.[13.8]and[13.9]torecommendmachine1becauseithasasho
First cost, $

Machine 1

Machine 2

12000

8000

Annual NCF, $/year

3000

1000 (years 1-5)

3000 (years 6-14)

Maximum life, years

14

Machine1:np=6.57years,whichislessthanthe7yearlife
0=$12000+$3000(P/A,15%,np)
Machine2:np=9.52years,whichislessthanthe14yearlife
0=$8000+$1000(P/A,15%,5)
+$3000(P/A,15%,np5)(P/F,15%,5)
Recommendation:Selectmachine1

$3000 per year

Machine 1
$12,000

np = 6.57

$3000 per year

$1000 per year

0 1

Machine 2
$8000

10

11 12 13

np = 9.52

14

Solution

ows for all years during the estimated (maximum) life. Compar

2470
s numerically larger that that of machine 1 at 15%. The result