Break-Even Analysis

Technique for evaluating process and equipment alternatives Objective is to find the point in dollars and units at which cost equals revenue Requires estimation of fixed costs, variable costs, and revenue

2006 Prentice Hall, Inc.

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Break-Even Analysis
Fixed costs are costs that continue even if no units are produced
Depreciation, taxes, debt, mortgage payments

Variable costs are costs that vary with the volume of units produced
Labor, materials, portion of utilities
Contribution is the difference between selling price and variable cost
2006 Prentice Hall, Inc. S7 2

Break-Even Analysis
Assumptions Costs and revenue are linear functions
Generally not the case in the real world

We actually know these costs

Very difficult to accomplish

There is no time value of money

2006 Prentice Hall, Inc. S7 3

Break-Even Analysis
900 800 700 Cost in dollars 600 Total revenue line

Break-even point Total cost = Total revenue

Total cost line

500
400 300 200 100
|

Variable cost

Fixed cost

Figure S7.5
2006 Prentice Hall, Inc.

| | | | | | | | | | | 0 100 200 300 400 500 600 700 800 900 1000 1100

Volume (units per period)

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Break-Even Analysis
BEPx = Break-even point in units BEP$ = Break-even point in dollars P = Price per unit (after all discounts) x = Number of units produced TR = Total revenue = Px F = Fixed costs V = Variable costs TC = Total costs = F + Vx

Break-even point occurs when

TR = TC or Px = F + Vx
2006 Prentice Hall, Inc.

F BEPx = P-V

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Break-Even Analysis
BEPx = Break-even point in units BEP$ = Break-even point in dollars P = Price per unit (after all discounts) x = Number of units produced TR = Total revenue = Px F = Fixed costs V = Variable costs TC = Total costs = F + Vx

BEP$ = BEPx P F = P P-V F = (P - V)/P F = 1 - V/P

2006 Prentice Hall, Inc.

Profit = TR - TC = Px - (F + Vx) = Px - F - Vx = (P - V)x - F

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Break-Even Example
Fixed costs = $10,000 Direct labor = $1.50/unit Material = $.75/unit Selling price = $4.00 per unit

$10,000 F BEP$ = = 1 - [(1.50 + .75)/(4.00)] 1 - (V/P)

2006 Prentice Hall, Inc.

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Break-Even Example
Fixed costs = $10,000 Direct labor = $1.50/unit Material = $.75/unit Selling price = $4.00 per unit

$10,000 F BEP$ = = 1 - [(1.50 + .75)/(4.00)] 1 - (V/P)

$10,000 = = $22,857.14 .4375 $10,000 F BEPx = = = 5,714 4.00 - (1.50 + .75) P-V

2006 Prentice Hall, Inc.

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Break-Even Example
50,000

40,000
30,000 20,000 10,000
| 0

Revenue Break-even point

Dollars

Total costs

Fixed costs

2,000

4,000

6,000 Units

8,000

10,000

2006 Prentice Hall, Inc.

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Break-Even Example
Multiproduct Case
BEP$ = F

Vi 1x (Wi) Pi

where

V P F W i

= variable cost per unit = price per unit = fixed costs = percent each product is of total dollar sales = each product

2006 Prentice Hall, Inc.

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Multiproduct Example
Fixed costs = $3,500 per month Item Sandwich Soft drink Baked potato Tea Salad bar Price $2.95 .80 1.55 .75 2.85 Cost $1.25 .30 .47 .25 1.00 Annual Forecasted Sales Units 7,000 7,000 5,000 5,000 3,000

2006 Prentice Hall, Inc.

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Multiproduct Example
Fixed costs = $3,500 per month Annual Forecasted Item Price Cost Sales Units Sandwich $2.95 $1.25 7,000 Soft drink .80 .30 7,000 Baked potato 1.55 .47 Annual 5,000 Weighted % of Contribution Tea Selling Variable .75 .25Forecasted 5,000 Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Salad bar 2.85 1.00 3,000
Sandwich Soft drink Baked potato Tea Salad bar $2.95 .80 1.55 .75 2.85 $1.25 .30 .47 .25 1.00 .42 .38 .30 .33 .35 .58 .62 .70 .67 .65 $20,650 5,600 7,750 3,750 8,550 $46,300 .446 .121 .167 .081 .185 1.000 .259 .075 .117 .054 .120 .625
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2006 Prentice Hall, Inc.

BEP Example = Multiproduct V 1 - P x (W ) F

$ i i i

Fixed costs = $3,500 per month $3,500 x Forecasted 12 Annual = = $67,200 .625 Item Price Cost Sales Units Sandwich $2.95 $1.25 7,000 $67,200 Daily Soft drink .80 .30 7,000 = = $215.38 sales 312 days Baked potato 1.55 .47 Annual 5,000 Weighted % of Contribution Tea Selling Variable .75 .25Forecasted 5,000 Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7) Salad bar 2.85 1.00 3,000 .446 x $215.38 = 32.6 .259 33 Sandwich $2.95 $1.25 .42 .58 $20,650 .446 $2.95 sandwiches
Soft drink Baked potato Tea Salad bar .80 1.55 .75 2.85 .30 .47 .38 .30 .33 .35 .62 .70 .67 .65 5,600 7,750 .121 .075 per day .167 .117 .054 .120 .625
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.25 1.00

3,750 8,550 $46,300

.081 .185 1.000

2006 Prentice Hall, Inc.