Breakeven Analysis: Gra W Hill

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
ENGINEERING ECONOMY Sixth

Edition Blank and
Tarquin
CHAPTER 13
BREAKEVEN ANALYSIS
M c
Gra
Hill
w
Blank & Tarquin: 5th edition. Ch.13 Authored by Dr. Don Smith, Texas A&M University 1
Chapter 13 Learning Objectives
1. The Breakeven Point.

2. Breakeven Analysis Between Two
Alternatives.
3. Spreadsheet Application – Using
Excel’s Solver for Breakeven
Analysis.
4. Chapter Summary.
CHAPTER 13
Section 13.1
Breakeven Analysis for a
Single Project
13.1 Understanding Breakeven
Given P, F, A, i, n;
If all of the parameters shown
above are known except one, then
the unknown parameter can be
calculated or approximated;
A breakeven value can be
determined by setting PW, FW, or
AW = 0 and solve or approximate
for the unknown parameter.
13.1 Solving for a Breakeven Value
Two approaches for solving for an

unknown parameter:
 1. Direct Solution manually if only one
interest factor is involved in the setup;
 2. Trial and Error – manually if multiple
factors are present in the formulation;
 3. Spreadsheet model where the Excel
financial functions { PV, FV, RATE, IRR,
NPV, PMT, and NPER are part of the
modeling process: (use Goal Seek or
Solver).
13.1 A Cost – Revenue Model Approach
A popular application of Breakeven (BE)

is where cost – revenue – volume
relationships are studied;
We define cost and revenue functions
and assume some linear or non-linear
cost or revenue relationships to model;
One objective: Find a parameter that
will minimize costs or maximize profits –
termed QBE .
13.1 Cost Models – Fixed Costs
Fixed Costs – Cost that do not vary

with production or activity levels
 Costs of buildings;
 Insurance;
 Fixed Overhead;
 Equipment capital recovery;
 etc.
13.1 Variable Costs
Costs that vary with the level of

activity;
 Direct Labor – wages;
 Materials;
 Indirect costs;
 Marketing;
 Advertising;
 Warranty;
 Etc.
13.1 Fixed Costs
Essentially constant for all values

of the variable in question;
If no level of activity, fixed costs
continue;
Must shut down the activity before
fixed costs can be altered
downward;
To buffer fixed costs one must
work on improved efficiencies of
operations.
13.1 Variable Costs
Variable Costs change with the

level of activity;
More activity – greater variable
costs;
Less activity – lover variable costs;
Variable costs are impacted by
efficiency of operation, improved
designs, quality, safety, and higher
sales volume.
13.1 Total Costs
Total Cost = Fixed Costs + Variable

Costs;
TC = FC + VC;
Profit Relationships;
Profit = Revenue – Total Cost
P = R – TC
P = R –{FC + VC}.
13.1 Cost – Revenue Relationships
Linear Models;
Non-linear models;
Linear and non-linear models are
used as approximations to reality;
A basic linear Cost Relationship is
shown on the next slide.
Figure 16-1 Linear and nonlinear revenue and cost relations used in breakeven analysis.
WCB/McGraw- © The McGraw-Hill Companies,
13.1 Basic Cost Relationship (Linear)
C
Total Costs
O
S
T
Variable Costs
Fixed Costs ( level)
Q – Level of Activity per time unit

13.1 Non-linear Models
Non-linear Models;
 One or more of the relationships is
(are) non-linear;
Example Follows:
13.1 Basic Cost Relationship (Linear)
C
Total Costs
O
S
T
Variable Costs
Fixed Costs ( level)
Q – Level of Activity per time unit

13.1 Breakeven
The breakeven point, QBE is the

point where the revenue and total
cost relationships intersect:
For non-linear forms, it is possible
to have more than one QBE point.
13.1 Breakeven…
Revenue and Total cost

relationships tend to be static in
nature;
May not truly reflect reality of the
dynamic firm;
However, the breakeven point(s)
can be useful for planning
purposes.
13.1 Reduction of Variable costs
BE point
Changes
When the
VC’s are
Lowered.
Figure 16-2 Effect on the breakeven point when the variable cost per unit is reduced.
13.1 Non-linear BE illustration
For non-linear analysis the point of

maximum profit is of interest;
And, multiple BE’s may exist;
See the next slide!
13.1 Non-linear Analysis
Breakeven Points
And Profit
Maximization for
A Non-linear Model
Figure 16-3 Breakeven points and maximum-profit point for a nonlinear analysis.
CHAPTER 13
Section 13.2
Breakeven Analysis Between
Two Alternatives
13.2 Two Alternative Analysis
Given two alternatives (assume

mutually exclusive)
Need to determine a common
variable or economic parameter
common to both alternatives;
Could be:
 Interest rate,
 First cost (investment),
 Annual operating cost,
 Etc.
13.2 Breakeven for two alternatives
Common analysis considers:

 Revenue or
 Costs
 Common to both options.
Assume a linear revenue-cost
relationship……
See figure 13-7 (next slide)…….
13.2 Breakeven for two alternatives
Total Cost
Relationships for
Two alternatives.
Note the intersection
Of the two TC
Plots. Both alternatives
Are equal.
13.2 Two Alternative Analysis
The preferred approach is to

define either a:
 Present worth relationships or,
 Annual worth relationships and,
 Set to two expressions equal and solve
for the parameter or variable of
interest.
13.2 Three Alternative Analysis
If three alternatives are present…

Compare the alternatives pair-wise
or,
Use a spreadsheet model to plot
the present worth or annual worth
over a specified range of values.
A typical three alternative plot
might look like ….
Breakeven for Three Alternatives
13. 2 Non-linear Breakeven
When variable cost relationships

are non-linear, the analysis
becomes more complicated;
Use of spreadsheet models and
plotting aids are suggested.
CHAPTER 13
Section 13.3
Spreadsheet Application – Using
Excel’s Solver for Breakeven
Analysis
13.3 Use of Excel’s Solver Tool
SOLVER is one of many built-in

Excel analysis tools;
Solver has been designed to aid in
more complex forms of “goal
seeking” and performing “what-if”
evaluations of properly constructed
models.
See Appendix A, Section A.4 of the
text.
13.3 SOLVER
For a properly constructed model

solver will require that the analyst:
 Specifies a target cell (the objective);
 One or more cell(s) that will have to
change in order to achieve the desired
target cell value.
13.3 Target Cell
The target cell MUST contain a

valid Excel formula or function;
One can:
 Maximize the target cell value or,
 Minimize the cell value 0r,
 Set to some predetermined cell value
(like “0”, etc.);
 The target cell cannot be a cell
reference;
13.3 Changing Cell(s)
Solver requires the analyst to

identify one or more cells that must
change to achieve the desired
result in the target cell;
Changing cells are, in reality, the
decision variables in the model;
One or more cells are identified
that directly or indirectly impact
the target cell.
13.3 Achieving the Target Cell

Objective
If the model is properly

constructed and the cell
formulas/functions are logically
linked then:
 Solver will iterate the designated
“change” cells until the target cell
value is achieved as close as possible.
 Solver will generate either exact
decision variable values or closely
approximated decision cell values.
13.3 Target Cell Achievement
If the proper linkages are built into

the model, solver can achieve
values for the various decision
values;
At times, solver might not find
feasible values for the decision
variables.
13.3 See Example 13.5
Example 13.5 page 436.

Note the application of the
financial functions PMT and PV in
this model.
13.3 Figure 13-10 Example 13.5
Cell to change – first

Cost of Machine 1
Target Cell
13.3 Changing Cell for Ex. 13.5
The objective here is to find the

breakeven value of Machine 1’s
initial first cost so that the two
machines are economically
identical at the 10% interest rate.
The analysis shows that if Machine
1 could be purchased for $6564
then the two alternatives will have
the same annual worth at 10%.
13.3 Additional Analysis
The example also shows what the

net cash flow for machine 1 must
be to equate to Machine 2.
Choice of what parameters to
study are left up to the analyist.
Chapter 13 Summary
Breakeven point for a variable X is

normally expressed as:
 Units per time period;
 Hours per month;
 Etc.
At breakeven, QBE one is indifferent
regarding a project.
Chapter 13 Summary cont.
Typical models are:

 Linear or,
 Non-linear.
Two or more alternatives can be
compared using breakeven
analysis;
BE analysis can be a form of
sensitivity analysis;
Complex models can be evaluated
using Excel’s Solver feature.
ENGINEERING ECONOMY Sixth

Edition
Blank and
Tarquin
End of Slide Set
Mc
Gra
Hill
w

Breakeven Analysis: Gra W Hill

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ENGINEERING ECONOMY Sixth

Chapter 13 Learning Objectives

1. The Breakeven Point.

13.1 Understanding Breakeven

13.1 Solving for a Breakeven Value

Two approaches for solving for an

13.1 A Cost – Revenue Model Approach

A popular application of Breakeven (BE)

13.1 Cost Models – Fixed Costs

Fixed Costs – Cost that do not vary

13.1 Variable Costs

Costs that vary with the level of

13.1 Fixed Costs

Essentially constant for all values

13.1 Variable Costs

Variable Costs change with the

13.1 Total Costs

Total Cost = Fixed Costs + Variable

13.1 Cost – Revenue Relationships

13.1 Basic Cost Relationship (Linear)

Fixed Costs ( level)

Q – Level of Activity per time unit

13.1 Non-linear Models

13.1 Basic Cost Relationship (Linear)

Fixed Costs ( level)

Q – Level of Activity per time unit

The breakeven point, QBE is the

Revenue and Total cost

13.1 Reduction of Variable costs

13.1 Non-linear BE illustration

For non-linear analysis the point of

13.1 Non-linear Analysis

13.2 Two Alternative Analysis

Given two alternatives (assume

13.2 Breakeven for two alternatives

Common analysis considers:

13.2 Breakeven for two alternatives

13.2 Two Alternative Analysis

The preferred approach is to

13.2 Three Alternative Analysis

If three alternatives are present…

Breakeven for Three Alternatives

13. 2 Non-linear Breakeven

When variable cost relationships

13.3 Use of Excel’s Solver Tool

SOLVER is one of many built-in

For a properly constructed model

13.3 Target Cell

The target cell MUST contain a

13.3 Changing Cell(s)

Solver requires the analyst to

13.3 Achieving the Target Cell

If the model is properly

13.3 Target Cell Achievement

If the proper linkages are built into

13.3 See Example 13.5

Example 13.5 page 436.

13.3 Figure 13-10 Example 13.5

Cell to change – first

13.3 Changing Cell for Ex. 13.5

The objective here is to find the