Sequence 10 _ Break Even

Analysis_Engineering Economics

Dr. Hassan Ashraf

Assistant Professor_ Civil Engineering Department _ CU Islamabad
_ Wah Campus
 Break Even Analysis
In general, “ Break-even analysis is the process of varying a parameter of a problem and
determining what parameter-value causes the performance measure to reach some
threshold or “break-even” value.”

Break even point can be defined as a point where the costs (expenses) and total sales
(revenue) are equal. Break even point can be described as a point where there is no net
profit or loss.

It is pertinent to recall that increase in MARR value reduces the present worth of an asset to
decrease. In a similar manner, the method of break even analysis across sufficient data
points allows economists and analysts to find out the break even point besides providing
information on other parameters of interest such as the time taken to reach break even
point, rate (slope) at which the break-even point is achieved.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 2
 Break Even Analysis
Another extremely important point to remember is finding out the variable of interest with
which the relationship of outcome variable is expected to be most sensitive. For example, in
order to understand the aforementioned argument, lets consider that an investor wants to
setup a plant that produces flexible European style garden chairs. The CEO of the
investment company is interested in knowing the parameters/variables which could have a
significant influence on the investment decision. He could possibly have a few variables to
look into which could include MARR, volumes of sales, price per unit, and other
parameters. Now, here the investor could perform variety of break-even analysis. One
possible break-even analysis could relate to the value of MARR and Present worth.
Another, break-even analysis could be related with the first cost or investment cost and the
relation with present worth. Also, another possible break even point could relate to the
savings in electricity costs and its influence on the present worth. Also, another break-even
point could be related with the number of sales and the generated revenue.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 3
 Break Even Chart for MARR

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 4
 Break Even Chart for First Cost

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 5
Break Even Chart for Electricity Savings

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 6
 Break Even Analysis
Break even analysis allows us to determine the range of values for a parameter within
which the project is viable or some other criteria are met. It can provide us with break-even
parameter values that give an indication of how much a parameter can change from its
original estimate before the project’s viability becomes a concern. Aforementioned graphs
reflect on the concept of break-even analysis.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 7
 A worked out example No.1
Actual Amount = 2500 Units; Fixed Cost = $3000; Variable Cost per unit = $1; Sale Price = $3

Output (Units) 0 1000 2000 3000

Fixed Costs 3000 3000 3000 3000
Variable Costs 0 1000 2000 3000
Total Costs 3000 4000 5000 6000
Total Revenue 0 3000 6000 9000

Chart Title
Total Cost Total Revenues
10000
9000
9000
8000 Break Even point at 1500 Units
7000 6000
6000
5000 4000
6000
4000 3000 5000
3000
2000
3000
1000
00
0 1000 2000 3000

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 8
 A worked out example No. 2
Another way to solve Break even analysis problem when the parameters of interest are sales
volume, sales price per unit, fixed cost is to employ Profit Equation.

We have seen Profit equation as:

Revenue – Expense = Profit

Revenue = Sales Price per unit x Number of Units

Expense = Variable Cost + Fixed Cost & Variable Cost = Variable Cost/ Unit * Number of Units

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 9
 A worked out example No. 2
How much profit will we earn this year if we produce and sell 1,000,000 units and our total fixed
costs for the year are $2,500,000? Consider the sale price per unit is $10 and variable cost per
unit is $6.

Using the Profit Eq. Presented in last slide

Revenue – Expense = Profit

Revenue – Expense = 0

Revenue = (1,000,000 Units) x (10$) = 10,000,000 $ …………………1

Total Expense = Variable Cost + Fixed Cost

For 1,000,000 Units to be produced and Sold

Total Expense = $2,500,000 + $6,000,000 = $8,500,000……………..2

Using the values of (1) and (2) in Profit Equation

Profit= (10,000,000) – (8,500,000) = 1,500,000 $

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 10
 A worked out example No. 2
(b) How many units need to be sold to achieve the break even?

Revenue – Expense = Profit

Revenue – Expense = 0

Let ‘U’ be representative of number of units sold

10 x U – 6 x U – 2,500,000=0

U= 2,500,000/ (10-6)

U= 625,000 Units ( must be sold to break even)

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 11
 Some more concepts
Contribution Margin per Unit = Sales Price Per Unit – Variable Cost per Unit

From the Last example,

Contribution Margin per Unit = $10 - $6 = $4

Break Even Point ( expresses in number of Units) = Total Fixed Cost/ Contribution Margin Per
Unit

= 2,500,000/ 4 = 625,000 units to break even

Contribution Margin Ratio = Contribution Margin/ Sales Price /Unit

= 4/10 = 0.4

Break Even Point ( expressed in dollar amount) = Total Fixed Cost/ Contribution Margin Ratio

= 2,500,000/0.4 = $ 6,250,000 in sales dollars to break even.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 12
 Some more concepts
Margin of Safety = Expected Sales – Breakeven Sales

Lets say, we assume the sales for the upcoming year to be 1,000,000 units.

From the previous problem,

Breakeven sales = $6,250,000

Expected sales = 1,000,000 X $10 = $10,000,000

Therefore:

The Margin of Safety = 10,000,000 – 6,250,000

= $3,750,000

Margin of Safety Ratio = Margin of Safety / Expected Sales

= 3,750,000/10,000,000
= 37.5%

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 13
 A worked out example
A home owner is considering whether to invest in solar panels. This homeowner has gathered the
following information for her town:

The average cost for residential energy is $ 0.124/kWh

The government subsidizes 70% of whatever is invested by the household.

Each square foot of panel produces 19.13 kWh every year.

The cost of installation per square foot of solar panel is $ 93.91

The house has 350 sq. ft of roof space. What is the break even point in years for the installation
of solar panels? Assume the homeowner’s interest rate is 6% per year.

The question is asking us to calculate the breakeven point in number of years where the savings
through solar panel would equal the amount of investment. Therefore what we need to do is to
calculate the amount saved for each year and then convert the value of each year to its present
worth. Plotting the data points will lead us to the breakeven point.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 14
 Break Even Analysis
The breakeven point is where the annual savings from the solar panels offsets the initial
investment. The initial investment is calculated as follows:

350 sq. ft of roof space x $93.91/sq.ft = $ 32, 869

With a 70% government subsidy, the purchase price is (0.3) ( 32,869) = $9,861

To find the break even point in years (X), we set the purchase price equal to the potential energy
savings

$ 9,861 = ( 350 sq.ft) (19.13 kWh/sq.ft-year) ($0.124/kWh) (P/A, 6%,X)

$9,861 = ( $ 830.24) (P/A,6%, X)

11.87 = (P/A, 6%, X)

From the interest table we could see that some where between 21 and 22 years we get the factor
of 11.87 . Therefore, we say that approximately, it would take 22 years to breakeven the
investment cost.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 15
 A worked out Example
Hybrid vehicles save on gasoline consumption by shutting off the vehicle’s engine while idling,
giving the vehicle a boost of electric power during acceleration, and capturing electrical energy
while braking. In addition to environmental benefits, the primary monetary benefit to the owner is
reduced fuel cost as a result of improved gas mileage. The trade-off, however, is that the
purchase price of the hybrid vehicle is higher than that of a standard-gasoline fueled engine.

Consider a hybrid vehicle with a price tag of $ 31,500. This vehicle will average 30 miles per
gallon of gasoline. A tax credit of 1,500 for the hybrid vehicle effectively reduces its price tag to $
$30,000. A comparably equipped gasoline-only vehicle will cost $ 28,000 and will average 25
miles per gallon of gasoline. Assuming an interest rate of 3% per year and a study period of five
years, find the breakeven of gasoline ($/gal) if the vehicle will be driven 18,000 miles each year.

To find the cost of gasoline that makes you indifferent between the two vehicles, you need to
develop an equivalent-worth equation in terms of the factor of interest – the cost of gasoline. In
this simple example, we are only considering the investment cost and fuel cost (annual
expenses). By default, we are assuming that the maintenance of the two vehicles will be the
same as will the future resale value.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 16
 A worked out Example
In this problem, we develop equivalent uniform annual cost (EUAC) expressions for each of the
vehicles.

Letting X = cost of gasoline, we get the following EUAC equations.

Hybrid : EUAC – Hybrid = (31,500 – 1,500) (A/P,3%,5) + $X/gal [(18,000 mi)/Year/ 30 mi/gal)]

Gas-only: EUAC-Has only= 28,000( A/P,3%,5)+ $X/gal [ 18,000 mi/Year/ 25 mi gallon)]

Equating both the equations and solving for X, breakeven cost of gasoline will come out to be
$3.64/gallon.

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 17
 Break Even Analysis

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 18
 Thank You

Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 19