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CH 2 - Break Even Analysis
CH 2 - Break Even Analysis
nor loss.
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Breakeven Point Analysis
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Breakeven Point Analysis
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Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000
2500 Revenue
2000
1500
1000
500
0
Units Sold 5
© Dale R. Geiger 2011
Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000
Column2
2500
Revenue
2000
1500
1000
500
0
Units Sold 6
© Dale R. Geiger 2011
Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000 Fixed Cost
2500 Column1
2000 Revenue
1500
1000
500
0
Units Sold 7
© Dale R. Geiger 2011
Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000 Fixed Cost
Variable Cost
2500
Total Cost
2000 Revenue
1500
1000
500
0
Units Sold 8
© Dale R. Geiger 2011
Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000 Fixed Cost
Variable Cost
2500
Total Cost
2000 Revenue
1500
1000
500
0
Units Sold 9
© Dale R. Geiger 2011
Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000 Fixed Cost
2500 Variable Cost
Total Cost
2000
Revenue
1500
1000
500
0
Units Sold 10
© Dale R. Geiger 2011
Graphic Depiction of Breakeven
$ 5000
4500
4000
3500
3000 Fixed Cost
Variable Cost
2500
Total Cost
2000 Revenue
1500
1000
500
0
Units Sold 11
© Dale R. Geiger 2011
Linear cost relationship
Total costs
Cost
Variable
costs
Level of activity
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The Breakeven Equation
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The Breakeven Equation
TC R or F VC Q SP Q
FC
or Q
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Sample Problem
The following costs are incurred per show at Sebastian’s
Theater Hall:
Facilities cost $500
Staff (actors who double as servers) 1000
Kitchen staff 200
Stage crew 300
Food cost (per ticket) 10
Ticket Price is $30
Task: Calculate the Breakeven number of tickets.
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Solving the Problem (part 1)
Identify the key variables in the equation
What are the fixed costs?
Facilities cost 500
Staff (actors who double as servers) 1000
Kitchen staff 200
Stage crew 300
Total 2000
What are the variable costs?
$10 Food/Ticket * #Tickets $10 Food/Ticket * #Tickets
What is the revenue?
$30 Price/Ticket * #Tickets
$30 Price/Ticket * #Tickets
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Solving the Problem (part 2)
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Solving the Problem (part 2)
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Solving the Problem (part 2)
($30-$10)(#Tickets) – $2000 = $0
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Solving the Problem (part 2)
Revenue – Variable Cost – Fixed Cost = Profit
Breakeven is the point where Profit = 0
$30(#Tickets) - $10(#Tickets) – $2000 = $0
($30-$10)(#Tickets) – $2000 = $0
$20(#Tickets) – $2000 = $0
#Tickets = $2000/$20
#Tickets = 100
#Tickets
20(#Tickets) = 2000
2/20/21 #Tickets = 2000/#Tickets = 100 20
Graphic Solution
Units Sold
21
© Dale R. Geiger 2011
Example
A road can be paved with either asphalt or concrete.
Concrete costs $15,000/km and lasts 20 years. What is
the maximum that should be spent on asphalt if it only
lasts 10 years? Annual maintenance costs for both
pavements are $500/km. MARR = 12%.
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Example Solved
Break-even point:
15,000(.1339) = PASPHALT(.1770)
PASPHALT = $11,347
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EXAMPLE
A proposed building may be roofed in either galvanized steel
sheet or composition roofing. The composition roof costs
$20,000 and must be replaced every 5 years at the same cost.
The steel roof costs $28,000 but the useful life is unknown.
Neither roof has any salvage value and no maintenance is
needed. If the minimum attractive rate of return (MARR)
equals 15%, what is the minimum life that the steel roof must
have to make it the better alternative?
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Solution
EACS = EACC
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Comparing different alternatives By
Break-even point
1. Define the common variable and its
dimensional units.
2. Use AW or PW analysis to express the
total cost of each alternative as a
function of the common variable.
3. Equate the two relations and solve for
the breakeven value of the variable.
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Example
A Yellow Pages directory company must decide whether it should compose
the ads for its clients in house or pay a production company to compose
them. To develop the ads in house, the company will have to purchase
computers, printers, and other peripheral at a cost of $12,000. The
equipment will have a useful life of 3 years, after which it will be sold for
$2000. The employee who creates the ads will be paid $45,000 per year.
In addition, each ad will have an average cost of $8 to prepare for delivery
to the printer. A total of 4000 ads are anticipated for the next few years.
Alternatively, the company can outsource ad development at a fee of $20
per ad regardless of the quantity. The current interest rate is 8% per year.
What is the breakeven amount, and which alternative is economically
better?
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Solution
Let x = ads per year
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Solution
Let FCB = fixed cost for B. Set total cost relations equal at
2000 units per year.
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Example
Work sheet on Chapter one.docx
Solver.xlsx
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Summary
The breakeven point for a problem can be
expressed as:
Units per time period
Hours per month
Price per unit
Etc.
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Summary
Revenue and cost can be:
Linear, or
Non-linear
Breakeven analysis is a form of
sensitivity analysis
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Benefit-Cost Ratio
Analysis
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Objective
Public sector
B/C for single project
Alternative selection
Multiple Alternative
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Public Project
Unit
Citizen of the
StateCountry
province
government
Nation
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Public Project
Reducing the effects of politics and special interests.
Performed correctly, the benefit/cost method will
always select the same alternative as PW, AW, and
ROR analyses.
provide services to the citizenry for the public good
at no profit.
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Public Project
Hospitals and clinics Transportation: highways,
Parks and recreation bridges, waterways
Utilities: water, electricity, gas,
Police and fire protection
sewer, sanitation Courts and prisons
Schools: primary, secondary, Food stamp and rent relief
community colleges, universities programs
Economic development Job training
Convention centers Public housing
Sports arenas Emergency relief
Codes and standards
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Private vs Public Sector
Characteristic Public sector Private sector
Size of investment Large More medium to small
Life estimate Longer (30-50 +) Shorter (2-25)
Revenues contributed to
Annual cash flow No profit: cost, benefit, dis
profit: costs are estimated
estimate benefit are estimated
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Public – Private partnership
Contracted under Build operate and Transfer (BoT)
Contractor : design and financing, and responsible for the
construction (the build element), operation (operate), and
maintenance activities for a specified number of years.
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Benefit/cost analysis of a single
project
All cost and benefit estimates must be converted to a
common equivalent monetary unit.
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Conventional B/C ratio
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Modified B/C ratio
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The benefit and cost difference
B - C. If (B - C) > 0,
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Alternative selection using incremental b/c
analysis
The incremental (conventional) B/C ratio is determined
using PW, AW, or FW calculations, and the extra-cost
alternative is justified if this B/C ratio is equal to or larger
than 1.0. The selection rule is as follows:
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Alternative selection using incremental b/c
analysis
Follow these steps to correctly perform a conventional B/C ratio
analysis of two alternatives.
Determine the total equivalent costs for both alternatives.
Order the alternatives by total equivalent cost; smaller first, then larger.
Calculate the incremental cost (∆C) for the larger-cost alternative. This is
the denominator in B/C.
Calculate the total equivalent benefits and any dis-benefits estimated for
both alternatives. Calculate the incremental benefits (∆B) for the larger cost
alternative. (This is ∆(B - D) if dis benefits are considered.)
Calculate the incremental B/C ratio using Equation, (B - D)/ c.
Use the selection guideline to select the higher-cost alternative if B/C >1.0.
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Example 1
1. Apply incremental B/C analysis at an interest rate of 8% per
year to determine which alternative should be selected. Use a
20-year study period, and assume the damage costs might
occur in year 6 of the study period.
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Alternative selection using incremental b/c
analysis
1. Determine the total equivalent costs for both alternatives.
Pw of Alt A = 600,000 + 50,000(P/A,8%,20)
Pw of Alt B = 800,000 + 70,000(P/A,8%,20)
2. Order the alternatives by total equivalent coast. Then calculate
the incremental cost (∆C) for the larger-cost alternative
∆C = (800,000 – 600,000) + (70,000 – 50,000)(P/A,8%,20) =
$396,362
3. Calculate the total equivalent benefit and any disbenefit. Then
calculate the incremental benefit (∆B).
∆B = (950,000 – 250,000)(P/F,8%,6) = 441,140
4. Calculate the incremental B/C
∆B/∆C = 441,140/396,362 = 1.11
5. Use the selection guideline to select the higher cost
alternative.
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Example 2
Soln
Device A Device B
Pw of cost = 1000 Pw of cost = 1000
Pw of benefit= 300(P/A,7%,5) Pw of benefit= 400(P/A,7%,5) –
= 300(4.100) 50(P/G,7%,5)
= 1230 = 400(4.100) – 50(7.647)
= 1258
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Example 3
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Incremental B/C analysis of multiple,
mutually exclusive alternatives
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Example 1
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Example 2
2. The Army Corps of Engineers wants to construct a dam on
a flood-prone river. The estimated construction cost and
average annual dollar benefits are listed below. (a) If a
6% per year rate applies and dam life is infinite for
analysis purposes, select the one best location using the
B/C method. If no site is acceptable, other sites will be
determined later. (b) If more than one dam site can be
selected, which sites are acceptable, using the B/C
method?
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Pay back period
Analysis
Reading Assignment
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