MODULE 5

CHAPTER IX
Fixed, Increment, and Sunk Costs
Types of Costs
Fixed costs are those costs which remain constant, whether or not a given
change in operations or policy is adopted.
Variable costs are those costs which vary with output or any change in the
activities of an enterprise.
Increment costs are those that arise as the result of a change in
operations or policy. Marginal cost is the additional cost of producing one
more unit of a product.
Sunk cost represents money which has been spent or capital which has
been invested and which cannot be recovered due to a certain reasons.
Example:
The ABC company has two plants in the same city ,each having a
capacity of ten units of the same product per month. Fixed cost of Plant I are
P30,000 per month and its variable cost are P1000X-P10X 2. Fixed costs of
Plant II are P50,000 per month and its variable costs are P11200Y- P5Y 3. X
and Y are the number of units produced. At present the sales have been
stabilized at 14 units per month with plant producing 7 units. Should the
production volume at the plants be changed, and to what extent?

Plant I : Variable Costs = P1000X –P10X2

X Variable Costs
4 P3840
5 4750
6 5640
7 6510
8 7360
9 8190
10 9000
Plant II : Variable Costs = P1200Y –P5Y3
Y Variable Costs
10 P7000
9 7155
8 7040
7 6685
6 6120
5 5375
4 4480

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 Units/month Variable Total Variable
Plant I Plant Costs Costs
II Plant I Plant
II
4 10 P3840 10,840
7000
5 9 4750 11,905
7155
6 8 5640 12,680
7040
7 7 6510 13195
6685
8 6 7360 6120 13,480
9 5 8190 13565
5375
10 4 9000 13480
4480

Operate Plant II at full capacity.

Chapter X
Break-even analysis, Benefit/ Cost ratio

A. Break-even analysis
In engineering economy many situations are encountered where the cost
of two or more alternatives may be affected by a common variable. Break-
even point is the value of the variable for which the costs for the alternatives
will be equal
C1 = f1(x) and C2 = f2 (x)

Where:
C1 = certain specified total cost applicable to alternative 1
C2 = certain specified total cost applicable to alternative 2
X = a common independent variable affecting alternative 1 and alternative
2
The break –even point is where C1 and C2 are equal,

f1(x) = f2 (x)
which may be solved for x , the break – even point.
Break – even chart is a graphical representation of break-even analysis. The
break –even point is the quantity of production at which the income is equal to
total cost. It is the intersection of tive the income line and the total on the
break-even chart. When two alternatives are to be compared , the break-even
2
point is the
intersection of the total cost line for each alternative on the break-even chart.
Example: A manufacturer produces a certain product at a labor cost
of P5.00 and material cost of P6.00 per piece. The fixed charges on his
business are P16,000 a month and the variable costs are P1.00 a piece. If the
product sells to retailers for P20,00 a piece, how many pieces must be
produced each month for the manufacturer to break even?
Let X = number of pieces to be produced each month to break even
Total income = P20(x)
Total costs = P16,000 + (P5.00+P6.00 + P1.00) (x)
= P16,000 + 12(x)
To breakeven,
20(x) = P16,000 +12(x)
X = 2,000 pieces
B. Benefit/ Cost ratio
The method of selecting alternatives that is most commonly used by
government agencies for analyzing the desirability of public projects is
the benefit- cost ratio( B/C ratio ). The B/C method of analysis is based
on the ratio of the benefits to costs associated with a particular project.
benefits−disbenefits
B/C = =
costs
Example: A land development costs P5,000,000 with the benefits of
P10,000,000 and dis - benefits of P1,500,000. What is the benefit-cost ratio?
Solution :
Benefits – Disbenefits
B/C = -----------------------------
Cost

P10,000,000 –P1,500,000
B/C = -------------------------------- = 1.7
P5,000,000
Exercises
1. Four alternatives for providing electric power supply to a small town
have been identified with the following annual benefits and costs:
Alternative Annual Benefits Annual Costs
A P1,528,000 P780,000
 B 1,398,000 664,000
C 960,000 742,000
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D 810,000 420,000
Select the best alternative using the B/C ratio analysis
( Select alternative A )
2. A project costs P100,000. The benefits at the end of each year for a
period of 5 years is equal to P40,000. Assuming money is worth 8%
with no salvage value, compute the benefit ratio. ( 1.597 )
3. Compute the benefit ratio of the following project:
Project Cost ------------------- P80,000
Gross income ----------------- P30,000/year
Operating Cost ---------------- P6,000/year
The life of the project is 8 years. Money is worth 8% ( 1.72 )
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