Chapter of

Break Even Analysis

To accompany
Quantitative Analysis for Management, Eleventh Edition,
by Render, Stair, and Hanna
Power Point slides created by Brian Peterson
 Learning Objectives
After completing this chapter, students will be able to:

1. Describe the quantitative analysis approach

2. Understand the application of quantitative
analysis in a real situation
3. Describe the use of modeling in quantitative
analysis
4. Use computers and spreadsheet models to
perform quantitative analysis
5. Discuss possible problems in using
quantitative analysis
6. Perform a break-even analysis

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 Chapter Outline
1.1 Introduction
1.2 What Is Quantitative Analysis?
1.3 The Quantitative Analysis Approach
1.4 How to Develop a Quantitative Analysis
Model
1.5 The Role of Computers and Spreadsheet
Models in the Quantitative Analysis
Approach
1.6 Possible Problems in the Quantitative
Analysis Approach
1.7 Implementation — Not Just the Final Step

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 Break Even Point Analysis
 Profit = sX – f – vX
 Contribution Margin (CM)= s – v

s-v
 Contribution Margin Ratio =
s * 100%
 Contribution Margin Ratio = Sales - Variable cost
* 100%
Sales

f f+target profit
 BEP(X)= BEP(with target profit)=
s–v s -v

f BEP(money)= BEP(X) * s
 BEP(money)=
CM Ratio BEP(X)= BEP(money) / s

 Margin of safety(X)= Forecast Sales(X) - BEP(X) 1-4

 Introduction

 Mathematical tools have been used for

thousands of years.
 Quantitative analysis can be applied to
a wide variety of problems.
 It’s not enough to just know the
mathematics of a technique.
 One must understand the specific
applicability of the technique, its
limitations, and its assumptions.

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 Examples of Quantitative Analyses

 In the mid 1990s, Taco Bell saved over $150

million using forecasting and scheduling
quantitative analysis models.
 NBC television increased revenues by over
$200 million between 1996 and 2000 by using
quantitative analysis to develop better sales
plans.
 Continental Airlines saved over $40 million in
2001 using quantitative analysis models to
quickly recover from weather delays and other
disruptions.

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 What is Quantitative Analysis?

Quantitative analysis is a scientific approach

to managerial decision making in which raw
data are processed and manipulated to
produce meaningful information.

Quantitative Meaningful
Raw Data Analysis Information

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 What is Quantitative Analysis?

 Quantitative factors are data that can be

accurately calculated. Examples include:
 Different investment alternatives
 Interest rates
 Inventory levels
 Demand
 Labor cost
 Qualitative factors are more difficult to
quantify but affect the decision process.
Examples include:
 The weather
 State and federal legislation
 Technological breakthroughs.

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 The Quantitative Analysis Approach

Defining the Problem

Developing a Model

Acquiring Input Data

Developing a Solution

Testing the Solution

Analyzing the Results

Implementing the Results

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Figure 1.1 1-9
 Defining the Problem
Develop a clear and concise statement that
gives direction and meaning to subsequent
steps.
 This may be the most important and difficult
step.
 It is essential to go beyond symptoms and
identify true causes.
 It may be necessary to concentrate on only a
few of the problems – selecting the right
problems is very important
 Specific and measurable objectives may have
to be developed.

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 Developing a Model
Quantitative analysis models are realistic,
solvable, and understandable mathematical
representations of a situation.

+ b 1X
$ Sales

Y= b 0

$ Advertising

There are different types of models:

Scale Schematic
models models
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 Developing a Model

Models generally contain variables

(controllable and uncontrollable) and
parameters.
 Controllable variables are the decision
variables and are generally unknown.
 How many items should be ordered for inventory?
 Parameters are known quantities that are a
part of the model.
 What is the holding cost of the inventory?

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 Acquiring Input Data

Input data must be accurate – GIGO rule:

Garbage
In
Process
Garbage
Out

Data may come from a variety of sources such as

company reports, company documents, interviews,
on-site direct measurement, or statistical sampling.
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 Developing a Solution

The best (optimal) solution to a problem is

found by manipulating the model variables
until a solution is found that is practical
and can be implemented.

Common techniques are

 Solving equations.
 Trial and error – trying various approaches
and picking the best result.
 Complete enumeration – trying all possible
values.
 Using an algorithm – a series of repeating
steps to reach a solution.
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 Testing the Solution

Both input data and the model should be

tested for accuracy before analysis and
implementation.
 New data can be collected to test the model.
 Results should be logical, consistent, and
represent the real situation.

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 Analyzing the Results
Determine the implications of the solution:
 Implementing results often requires change in
an organization.
 The impact of actions or changes needs to be
studied and understood before
implementation.

Sensitivity analysis determines how much

the results will change if the model or
input data changes.
 Sensitive models should be very thoroughly
tested.
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 Implementing the Results
Implementation incorporates the solution
into the company.
 Implementation can be very difficult.
 People may be resistant to changes.
 Many quantitative analysis efforts have failed
because a good, workable solution was not
properly implemented.

Changes occur over time, so even

successful implementations must be
monitored to determine if modifications are
necessary.
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 How To Develop a Quantitative
Analysis Model
Expenses can be represented as the sum of fixed and
variable costs. Variable costs are the product of unit
costs times the number of units.
Profit = Revenue – (Fixed cost + Variable cost)
Profit = (Selling price per unit)(number of units
sold) – [Fixed cost + (Variable costs per
unit)(Number of units sold)]
Profit = sX – [f + vX]
Profit = sX – f – vX

where
s = selling price per unit v = variable cost per unit
f = fixed cost X = number of units sold
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 How To Develop a Quantitative
Analysis Model
Expenses can be represented as the sum of fixed and
variable costs and variable costs are the
The parameters product
of this modelof
unit costs times the number
are f, v,of units
and s as these are the
inputscost
Profit = Revenue – (Fixed inherent in the cost)
+ Variable model
Profit = (Selling priceThe
perdecision variable
unit)(number of of
units
sold) – [Fixedinterest
cost +is(Variable
X costs per
unit)(Number of units sold)]
Profit = sX – [f + vX]
Profit = sX – f – vX

where
s = selling price per unit v = variable cost per unit
f = fixed cost X = number of units sold
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 Example: Pritchett’s Company
The company buys, sells, and repairs old clocks.
Rebuilt springs sell for $10 per unit. Fixed cost of
equipment to build springs is $1,000. Variable cost
for spring material is $5 per unit.

s = 10 f = 1,000 v=5
Number of spring sets sold = X
Profits = sX – f – vX

If sales (X= 0) item, profits = -f = –$1,000.

If sales (X= 1000) items,
profits = [(10)(1,000) – 1,000 – (5)(1,000)]
= $4,000
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 Pritchett’s company
Companies are often interested in the break-even
point (BEP). The BEP is the number of units sold
that will result in $0 profit.

0 = sX – f – vX, or 0 = (s – v)X – f
Solving for X, we have
f = (s – v)X
f
X=
s–v

Fixed cost
BEP =
(Selling price per unit) – (Variable cost per unit)

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 Pritchett’s company
Companies are often interested in their break-even
point (BEP). The BEP is the number of units sold
BEP for Pritchett’s Precious Time Pieces
that will result in $0 profit.
BEP
0= sX –= f$1,000/($10
– vX, or – 0$5) = –200
= (s v)Xunits
–f
Salesfor
Solving of less
X, wethan
have 200 units of rebuilt springs
will result in a loss.
f = (s – v)X
Sales of over 200 units of rebuilt springs will
result in a profit. X = f
s–v

Fixed cost
BEP =
(Selling price per unit) – (Variable cost per unit)

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 Modeling in the Real World

Quantitative analysis models are used

extensively by real organizations to solve
real problems.
 In the real world, quantitative analysis
models can be complex, expensive, and
difficult to sell.
 Following the steps in the process is an
important component of success.

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 Advantages of Mathematical Modeling

1. Models can accurately represent

reality.
2. Models can help a decision maker
formulate problems.
3. Models can give us insight and
information.
4. Models can save time and money in
decision making and problem solving.
5. A model may be the only way to solve
large or complex problems in a timely
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 Models Categorized by Risk

 Mathematical models that do not

involve risk are called deterministic
models.
 All of the values used in the model are
known with complete certainty.
 Mathematical models that involve
risk, chance, or uncertainty are
called probabilistic models.
 Values used in the model are
estimates based on probabilities.
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 Computers and Spreadsheet Models

QM for Windows
 An easy to use
decision support
system for use in
POM and QM
courses
 This is the main
menu of
quantitative
models

Program 1.1

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 Computers and Spreadsheet Models
Excel QM’s Main Menu (2010)
 Works automatically within Excel spreadsheets

Program 1.2

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 Computers and Spreadsheet Models

Selecting
Break-Even
Analysis in
Excel QM

Program 1.3A

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 Computers and Spreadsheet Models

Break-
Even
Analysis
in Excel
QM

Program 1.3B

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 Computers and Spreadsheet Models

Using Goal
Seek in the
Break-
Even
Problem

Program 1.4

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 Possible Problems in the
Quantitative Analysis Approach
Defining the problem
 Problems may not be easily identified.
 There may be conflicting viewpoints
 There may be an impact on other
departments.
 Beginning assumptions may lead to a
particular conclusion.
 The solution may be outdated.

Developing a model
 Manager’s perception may not fit a textbook
model.
 There is a trade-off between complexity and
ease of understanding.
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 Possible Problems in the
Quantitative Analysis Approach
Acquiring accurate input data
 Accounting data may not be collected for
quantitative problems.
 The validity of the data may be suspect.
Developing an appropriate solution
 The mathematics may be hard to understand.
 Having only one answer may be limiting.
Testing the solution for validity
Analyzing the results in terms of the whole
organization
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 Question 2
 The Sheraton Brick Company manufactures a
standard stone block for the building industry.
The production capacity for the year is 100,000
standard blocks. The selling price per block is
$1.60, variable costs are $0.80 per brick and
fixed costs are $60,000 per annum.
 Determine:
 Analyze break-even point in terms of sales
“money” and output “items”.
 Analyze “Profit/Loss” if the forecast of sales to
be 90,000 bricks in the year.
1-35
 Question 3
 A company makes a product with a selling
price of $20 per unit and variable costs of
$12 per unit. The fixed costs for the period
are $40,000.
 Analyze break-even point in terms of sales
“money” and output “items”.
 What is the required sales level to reach a
target profit of $10,000?
 In case the forecast of sales to be 6500
items, analyze the margin of safety
1-36
 Question 4
 A company produces one product with a selling
price of $72.00. The fixed costs are of $200000 for
rent and $100000 for stationary per annum. While
the variable material cost of $30.00 per unit and
variable labor cost of $12.00 per unit. The
maximum factory capacity is 20000 units, and it
anticipates selling 15000 units.
 Analyze break-even point in terms of sales (in units
and money)
 Analyze margin of safety if the company reach to
its forecast (in units and money)
 Analyze the profit if the company reach to its
maximum capacity
1-37
 Question 5
 P&M Company produces a single article.
Following cost data is given about its product:‐ 
 Selling price per unit       $40
 Marginal cost per unit       $24
 Fixed cost per annum       $16000
 Calculate:       
(a) CMR (P/V ratio)
(b) break even sales
(c) sales to earn a profit of $2,000
(d) Profit at sales of $60,000
(e) New break even sales, if price is reduced by 10%.
 Question 6
 P&M Company produces a single article.
Following cost data is given about its product:‐ 
• Selling price per unit       $40
• Contribution Margin (P/V)       $16
• Fixed cost per annum       $16000
 Calculate:       
(a) CMR (P/V ratio)
(b) break even sales
(c) sales to earn a profit of $2,000
(d) Profit at sales of $60,000
(e) New break even sales, if price is reduced by 10%.

1-39
 Question 7

 From the following information's find

out:
 Fixed Cost = $40, 000
 T.Profit = $20,000  
 B.E.P(T.P) = $80,000

 a. CMR (P/V Ratio)

 b. B.E.P
 c. Margin of Safety at B.E.P(T.P) sales
 Question 8

 B&N company manufactures a single

product having a marginal cost of
$1.50 per unit.   Fixed cost is $30,000
per annum. The market is such that
up to 45,000 units can be sold at a
price of $2.00 per unit, but any
additional sale must be made at
$3.00 per unit. Company has a
planned profit of $50,000.
 How many units must be made and
sold to reach planned profit (T.P)?
 Question 9
• M&N company manufacture three products. The following is
the cost data relating to products A, B, and C.

Products A B C Total
($1000 ($1000 ($1000 ($100
) ) ) 0)
Sales 150 90 60 300
Variable Cost 120 63 36 219
Contribution 30 27 24 81
Fixed Cost 40.5
profitability
profit

• Do you think the company can increase its profits by changing the
production mix? (suppose the company will keep the production capacity the
same)
• (Let’s see the effect on profit if sale of product B and C is increased by $30,
000 each and product A by reducing $60, 000