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Break-Even Analysis

Greg Hiatt
May 5, 2002
Defined:
Break-even analysis examines the
demand volume.
Overview:
Break-Even Analysis

• Benefits
• Defining Page
• Getting Started
• Break-even Analysis
– Break-even point
– Comparing variables
• Algebraic Approach
• Graphical Approach
Benefits and Uses:
• The evaluation to determine
necessary levels of service or
production to avoid loss.

• Comparing different variables to

determine best case scenario.
Defining Page:
• USP = Unit Selling Price

• UVC = Unit Variable costs

• FC = Fixed Costs

• Q = Quantity of output units

sold (and manufactured)
Defining Page:
Cont.

• OI = Operating Income

• TR = Total Revenue

• TC = Total Cost

• USP = Unit Selling Price

Getting Started:
• Determination of which equation
method to use:
– Basic equation
– Contribution margin equation
– Graphical display
Break-even analysis:
Break-even point
• John sells a product for \$10 and it
cost \$5 to produce (UVC) and has
fixed cost (FC) of \$25,000 per year

break-even?

• How much will he need to sell to

make \$1000?
Algebraic approach:
Basic equation
Revenues – Variable cost – Fixed cost = OI
(USP x Q) – (UVC x Q) – FC = OI
\$10Q - \$5Q – \$25,000 = \$ 0.00
\$5Q = \$25,000
Q = 5,000

What quantity demand will earn \$1,000?

\$10Q - \$5Q - \$25,000 = \$ 1,000
\$5Q = \$26,000
Q = 5,200
Algebraic approach:
Contribution Margin equation
(USP – UVC) x Q = FC + OI
Q = FC + OI
UMC
Q = \$25,000 + 0
\$5
Q = 5,000
What quantity needs sold to make \$1,000?
Q = \$25,000 + \$1,000
\$5
Q = 5,200
Graphical analysis:
Doll ars
70,000
60,000 Total Cost
Line
50,000
40,000
30,000
20,000
Total Revenue
10,000 Line Break-even point
0
1000 2000 3000 4000 5000 6000
Quantity
Graphical analysis:
Cont.
Dol lars
70,000
60,000 Total Cost
Line
50,000
40,000
30,000
20,000
Total Revenue
10,000 Line Break-even point
0
1000 2000 3000 4000 5000 6000
Quantity
Scenario 1:
Break-even Analysis Simplified

• When total revenue is equal to total

cost the process is at the break-even
point.

TC = TR
Break-even Analysis:
Comparing different variables
• Company XYZ has to choose
between two machines to purchase.
The selling price is \$10 per unit.

• Machine A: annual cost of \$3000 with

per unit cost (VC) of \$5.

• Machine B: annual cost of \$8000 with

per unit cost (VC) of \$2.
Break-even analysis:
Comparative analysis Part 1

• Determine break-even point for

Machine A and Machine B.

• Where: V = FC
SP - VC
Break-even analysis:
Part 1, Cont.

Machine A:
v = \$3,000
\$10 - \$5
= 600 units
Machine B:
v = \$8,000
\$10 - \$2
= 1000 units
Part 1: Comparison
• Compare the two results to
determine minimum quantity sold.

• Part 1 shows:
– 600 units are the minimum.
– Demand of 600 you would choose
Machine A.
Part 2: Comparison
Finding point of indifference between
Machine A and Machine B will give
the quantity demand required to
select Machine B over Machine A.

Machine A = Machine B
FC + VC = FC + VC
\$3,000 + \$5 Q = \$8,000 + \$2Q
\$3Q = \$5,000
Q = 1667
Part 2: Comparison
Cont.

will choose:

• Machine A when quantity demanded

is between 600 and 1667.

• Machine B when quantity demanded

exceeds 1667.
Part 2: Comparison
Graphically displayed
Doll ars
21,000
18,000 Machine A
15,000
12,000
9,000 Machine B
6,000
3,000
0
500 1000 1500 2000 2500 3000
Quantity
Part 2: Comparison
Graphically displayed Cont.
Doll ars
21,000
18,000 Machine A
15,000
12,000
9,000 Machine B
6,000
3,000 Point of indifference
0
500 1000 1500 2000 2500 3000
Quantity
Exercise 1:
• Company ABC sell widgets for \$30 a
unit.

• What is the break-even point using

the basic algebraic approach?
Exercise 1:

Revenues – Variable cost - Fixed cost = OI

(USP x Q) – (UVC x Q) – FC = OI
\$30Q - \$10Q – \$100,00 = \$ 0.00
\$20Q = \$100,000
Q = 5,000
Exercise 2:
• Company DEF has a choice of two
machines to purchase. They both
make the same product which sells
for \$10.
• Machine A has FC of \$5,000 and a per
unit cost of \$5.
• Machine B has FC of \$15,000 and a
per unit cost of \$1.

• Under what conditions would you

select Machine A?
Exercise 2:
Step 1: Break-even analysis on both
options.
Machine A:
v = \$5,000
\$10 - \$5
= 1000 units
Machine B:
v = \$15,000
\$10 - \$1
= 1667 units
Exercise 2:
Machine A = Machine B
FC + VC = FC + VC
\$5,000 + \$5 Q = \$15,000 + \$1Q
\$4Q = \$10,000
Q = 2500

• Machine A should be purchased if

expected demand is between 1000
and 2500 units per year.
Summary:
• Break-even analysis can be an
effective tool in determining the cost
effectiveness of a product.

• Use as a comparison tool for making

a decision.
Bibliography:
Russel, Roberta S., and Bernard W.
Taylor III. Operations Management.