Topic 4 Finals BREAK EVEN Analysis

BREAK-EVEN ANALYSIS
In engineering economy, many situations are encountered where the cost of two or more
alternatives may be affected by a common variable. Break-even analysis is useful in the
determination of the level of production or in a targeted desired sales mix. The analysis is for
management’s use only as the metric and calculations are often not required to be disclosed to
external sources such as investors, regulators or financial institutions. Break-even analysis looks
at the level of fixed costs relative to the profit earned by each additional unit produced and sold.
In general, a company with lower fixed costs will have a lower break-even point of sale. For
example, a company with 0 of fixed costs will automatically have broken even upon the sale of
the first product assuming variable costs do not exceed sales revenue. However, the
accumulation of variable costs will limit the leverage of the company as these expenses are
incurred for each item sold.
The calculation of break-even analysis may be performed using two formulas. First, the
total fixed costs are divided the unit contribution margin. In the example above, assume total
company fixed costs are 20,000. With a contribution margin of 40, the break-even point is 500
units (20,000 divided by 40). Upon the sale of 500 units, all fixed costs will be paid for, and the
company will report a net profit or loss of 0.
Alternatively, the break-even point in sales dollars is calculated by dividing total fixed
costs by the contribution margin ratio. The contribution margin ratio is the contribution margin
per unit divided by the sale price. Using the example above, the contribution margin ratio is 40%
(40 contribution margin per unit divided by 100 sale price per unit). Therefore, the break-even
point in sales is 50,000 (20,000 total fixed costs divided by 40%). This figured may be confirmed
as the break-even in units (500) multiplied by the sale price (100) equals 50,000.
Break-even point is the value of the variable for which the costs for the alternatives will
be equal
C1 = f1(x) and C2 = f2(x)

where
C1 = certain specified total cost applicable to alternative 1

C2 = certain specified total cost applicable to alternative 2
x = a common independent variable affecting alternative 1 and alternative 2
The break-even point is where C1 and C2 are equal

f1(x) = f2(x)
which may be solved for x, the break-even point.
Break even point
It is the point at which total cost and total revenue are equal. There is no net loss or gain,
and one has "broken even," though opportunity costs have been paid and capital has received the
risk-adjusted, expected return. In short, all costs that must be paid are paid, and there is neither
profit nor loss
Break-even Chart
Break-even chart is a graphical representation of break-even analysis. The break-even

point is the quantity of production at which the income is equal to total cost line on the break-even
chart.
When two alternatives are to be compared, the break-even point is the intersection of the
total cost line for each alternative on the break-even chart.
Examples:
1. A manufacturer produces certain items at a labor cost per unit of 315, materials cost per
unit is 100, variable cost of 3.00 each. If the item has a selling price of 995, how many
units must be manufactured each month for the manufacturer to breakeven if the monthly
overhead is 461 600?
Let x = number of units to be manufactured per month to break even
Material cost = 100x
Labor cost = 315x
Variable cost = 3x
Total expenses = (100x +315x +_3x) + 461 600 = 418x + 461 600
Total income = 995x
To breakeven; income = expenses
995x = 418x + 461 600; x = 800, to breakeven, there should be 800 units to be
manufactured each month
2. The annual maintenance cost of a machine is 70,000. If forging cost is 56 and the selling
price is 125 per forged unit, find the number of units to be forged to breakeven?
Let x = Number of units to be forged to breakeven
Income = expenses
125x = 56x + 70,000
69x = 70000
X = 1014.49 units of 1015 units
Problems for practice:

1. The annual maintenance cost of the machine shop is 69 994. If the cost of making a forging
is 56 per unit and its selling price is 135 per forged unit, find the number of units to be
forged to breakeven. (886 units)
2. A manufacturer produces certain items at a labor cost of 115 each, material cost of 76 each
and variable cost of 2.32 each. If the item has a unit price of 600, how many units must be
manufactured each month for the manufacturer to breakeven if 428,000 is the monthly
overhead cost. (1053 units)
3. Mighty drum manufacturer incurs a yearly fixed operating cost of 200,000. The
manufactured cost for each drum is 160 to produce and it sells at 200. What is the
breakeven sales volume of the manufacturer in drums per year? (5,000)
4. Rexy which manufactures electric motors has a production capacity of 200 motors a month.
The variable costs are 150 per motor. The average selling price of the motors is 275. Fixed
cost amounting to 20,000 per month that includes taxes. Find the number of motors that
must be sold every month to breakeven. (160 motors)
5. Mageteng produces a certain construction material at a labor cost of 16.20 per piece,
materials cost 38.50 per piece and variable cost of 7.40 per piece. The fixed charge on the
business is 100,000 per month. If the finished product is sold at 95 each, how much pieces
must be manufactured in each month to breakeven? (3040)
6. The Philippine Transmission Company makes and sell automotive parts. 500,000 units per
year is the present sales volume at a selling price 0.50 each per unit. Fixed expenses total
80,000 per year. What is the present breakeven points in units? (160,000).
7. The cost of a small transistor radio set is 230 for labor and 370 for material. The fixed
charges in operating the plant is 1,000,000 per month. The variable cost is 10 per set and
the radio can be sold at 750 each. Determine how many sets must be produced per month
to break even. (7143 units)
8. The direct labor cost and material cost of a certain product are 300 and 400 per unit,
respectively. Fixed charges are 100,000 per month and other variable costs are 100 per
unit. If the product is sold at 1200 per unit, how many units must be produced and sold to
breakeven? (250).
9. Two machines are being considered for the production of a particular part for which there
is a long-term demand. Machine A costs P50 000 and is expected to last 3 years and have
a P10 000 salvage value. Machine B costs P75 000 and is expected to last 6 years and has
zero salvage value. Machine A can produce a part in 18 seconds, <Machine B requires
only 12 seconds per part. The out-of-pocket hourly cost of operation is P38 for A and P30
for B. Monthly maintenance costs are P200 for A and P220 for B.
If interest on invested capital is 25%, determine the number of parts per year at which
the machines are equally economical. If the expected number of parts per year is greater
than this break-even quantity, which machine would be favored?
10. Two electric motors are being considered to power an industrial hoist. Each is capable of
providing 100 hp. Pertinent data for each motor are as follows:
Motor A Motor B
Investment P25 000 P32 000
Electrical efficiency 84% 88%
Maintenance per year 400 600
Life, years 10 10
Money is worth 20%. If the expected usage of the hoist is 700 hours per year, what would
the cost of electrical power have to be before Motor A is favored over Motor B?

Topic 4 Finals BREAK EVEN Analysis

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BREAK-EVEN ANALYSIS

C1 = f1(x) and C2 = f2(x)

C1 = certain specified total cost applicable to alternative 1

The break-even point is where C1 and C2 are equal

Break even point

Break-even chart is a graphical representation of break-even analysis. The break-even

Problems for practice:

Investment P25 000 P32 000

Electrical efficiency 84% 88%

Maintenance per year 400 600

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