MGS 3310

Break-Even and Cross-Over Analyses

The Generalized Profit Model:

A decision-maker will break-even when profit is zero. We will develop the formula for the
break-even point by setting the generalized profit model equal to zero, and then solve for the
quantity (Q). For simplicity, we will assume that the quantity produced is equal to the quantity
sold. This assumption will be relaxed in the chapter on decision theory.

Profit (π) = Revenue (R) - Cost (C)

Revenue (R) = Selling price per unit (SP) x Quantity sold (Qs)

Cost (C) = [Variable cost per unit (VC) x Quantity produced (Qp)] + Fixed Cost (FC)

For now, Let Qp = Qs

Therefore, π = R-C

π = (SP*Q)-[(VC*Q) + FC]

π = SP*Q - VC*Q - FC

π = (SP-VC)*Q - FC

If Contribution Margin (CM) = SP-VC, then…

π = CM*Q - FC, and

Q = (FC + π)/CM

From this formula, we can determine the quantity to produce and sell that will yield a profit of π
dollars. For example:

If fixed cost is $150,000 per year, selling price per unit (SP) is $400, and variable cost per unit
(VC) is $250, what quantity (Q) will produce a profit of $300,000?

CM = SP - VC = 400 - 250 = 150

Q = (FC + π)/CM = (150,000 + 300,000)/150 = 450,000/150 = 3000 units

Breakeven Point:

By setting π = 0 and solving for Q, we find the break-even quantity, as follows:

0 = CM*QBE - FC

FC = CM*QBE

FC/CM = QBE

QBE = FC/CM

For example, if:

FC = 150,000
VC = 250
SP = 400
} CM = 150

QBE = 150,000/150 = 1000 units

Pictorially:

Π
Break-Even Point

0
1000 Q

-150,000
Cross-Over Point (Indifference Point):
The cross-over (or “indifference”) point is found when we are indifferent between two plans. In
other words, this is the value of Q when profit is the same for each of two plans. To find the
cross-over point for Plan A and B:

πA = CMA*QA - FCA
Set πA equal to πB and solve for value of Q
πB = CMB*QB - FCB

Let’s call this “cross-over point” (between Plans A and B) Q “AtoB” (or, in general, “Qco”). Therefore, setting the
two equations equal to each other and solving for Q:

QAtoB = (FCA - FCB)/(CMA - CMB)

To illustrate the cross-over point, let’s look at three strategies or plans:

Plan A Plan B Plan C

FC 150,000 450,000 2,850,000
VC
SP
250
400 }150
150
}
400 250
100
}
400 300

Breakeven Points for each plan are:

Plan A Plan B Plan C

QBE = 150,000/(400-250) 450,000/(400-150) 2,850,000/(400-100)

= 1000 units = 1800 units = 9500 units

And, by definition, the profit at each break-even point is zero.

Crossover Points:

A to B B to C
QCO (150,000-450,000)/(150-250) (450,000-2,850,000)/(250-300)
= 3000 units = 48,000 units
πA = at
And since π = CM*Q - FC, the profit CM A*Q - FCA
each cross-over point is:
πB = CMB*Q - FCB
= 150(3000) - 150,000
= 250(48,000) - 450,000
= $300,000, or
= $11,550,000, or
πB = 250(3000) - 450,000
πC = 300(48000) - 2,850,000
= $300,000
= $11,550,000
 To interpret the answers, we are “indifferent” between Plan A and Plan B when Q = 3000 units,
and either Plan A or B would yield a profit of $300,000 when Q = 3000 units. We are also
“indifferent” between Plan B and Plan C when Q = 48000 units, and either Plan B or C would
yield a profit of $11,550,000 when Q = 48000 units. Pictorially:
KEY:
A
B
C

Π
NOT TO SCALE

Crossover Points

3,000 48,000

Below 1000 units, none of the strategies would break-even. And remember that the generalized profit
model above can be used to find the amount of profit for a plan at any value of Q. Therefore, depending
on the number of units produced and sold (Q), the best plan to pursue would be as follows:

Units (Q) Decision

0-999 Don’t produce
1000-2999 Plan A
3000 Plan A or Plan B
3001-47,999 Plan B
48,000 Plan B or Plan C
>48,000 Plan C