Chapter 13

Breakeven
Analysis

Lecture slides to accompany

Engineering Economy
7th edition

Leland Blank
Anthony Tarquin

© 2012 by McGraw-Hill All Rights Reserved

13-1
 LEARNING OUTCOMES

1. Breakeven point – one parameter

2. Breakeven point – two alternatives

13-2 © 2012 by McGraw-Hill All Rights Reserved

 Fix Cost FC
Example
You decided to sell Only coffee using Nespresso machine during Ramdan
Nespresso Machine Cost is 2,000 SAR
One Sugar + One Disposable Cup + one Coffee Capsule = 5 SAR per coffee
You decided to sell one coffee for 15 SAR Variable Cost - V

1- Find the breakeven quantity?

2- Find profit or loss if you sold 80 coffees
3- Find profit or loss if you sold 300 coffees Selling Price - R
4- Find profit or loss if you sold 200 coffees

1- QBE= FC / (R-V) = 1000/ (15-5) = 200 Coffee (Breakeven) QB*

2- Profit/loss = ( R-V)Q – FC => (15-5)*80 - 2000= -1600 (loss)
3- Profit/loss = ( R-V)Q – FC => (15-5)*300 - 2000= 1000 (Profit)
4- 3- Profit/loss = ( R-V)Q – FC => (15-5)*200 - 2000= 0 ( no profit or loss because you are
selling the breakeven quantity)

© 2012 by McGraw-Hill All Rights

3
Reserved
 Breakeven Point
Value of a parameter that makes two elements equal
The parameter (or variable) can be an amount
of revenue, cost, supply, demand, etc. for one
project or between two alternatives
 One project - Breakeven point is identified as QBE.
Determined using linear math relations for revenue
and cost.
 Between two alternatives - Determine one of the
parameters P, A, F, i, or n with others constant

13-3 © 2012 by McGraw-Hill All Rights Reserved

 Cost-Revenue Model ― One Project
Quantity, Q — An amount of the variable in
question, e.g., units/year, hours/month
Breakeven value is QBE

Fixed cost, FC — Costs not directly dependent on the variable, e.g.,

buildings, fixed overhead, insurance, minimum workforce cost
Variable cost, VC — Costs that change with parameters such as production
level and workforce size. These are labor, material and marketing
costs. Variable cost per unit is v
Total cost, TC — Sum of fixed and variable costs, TC = FC + VC

Revenue, R — Amount is Profit, P — Amount of revenue

dependent on quantity sold remaining after costs
Revenue per unit is r P = R – TC = R – (FC+VC)
© 2012 by McGraw-Hill All Rights Reserved
13-4
 Breakeven for linear R and TC

Set R = TC and solve for Q = QBE

R = TC
rQ = FC + vQ

QBE = FC
r–v

When variable cost, v, is

lowered, QBE decreases
(moves to left)

13-5 © 2012 by McGraw-Hill All Rights Reserved

 Example: One Project Breakeven Point
A plant produces 15,000 units/month. Q
Find breakeven level if FC = $75,000 /month,
revenue is R= $8/unit and
variable cost FC is $2.50/unit.
Determine expected monthly profit or loss.

Solution: Find QBE and compare to 15,000; calculate Profit

QBE = 75,000 / (8.00-2.50) = 13,636 units/month
QBE = FC
Production level is above breakeven Profit r–v
Profit = R – (FC + VC)
= rQ – (FC + vQ) = (r-v)Q – FC

Profit = (r-v)Q – FC

= (8.00 – 2.50)( 15,000) / 75,000

= $ 7500/month

13-6 © 2012 by McGraw-Hill All Rights Reserved

 Example: One Project Breakeven Point
Handheld fiber-optic meters with white light polarization
interferometry are useful for measuring temperature, pressure, and
strain in electrically noisy environments.
The fixed costs associated with manufacturing are $800,000 per year.
If a base unit sells for $2950 and
its variable cost is $2075,
( a ) how many units must be sold each year for breakeven and
( b ) what will the profit be for sales of 3000 units per year?

(a) QBE = 800,000/(2950 – 2075)

= 914 units per year
(b) P = (2950 – 2075)(3000) – 800,000
= $1,825,000 per year

8
 Breakeven Between Two Alternatives
To determine value of common variable between 2 alternatives, do the
following:
1. Define the common variable
2. Develop equivalence PW, AW or FW relations as function of common
variable for each alternative
3. Equate the relations; solve for variable. This is the breakeven value

Selection of alternative is based on

anticipated value of common
variable:

 Value BELOW breakeven;

select higher variable cost

 Value ABOVE breakeven;

select lower variable cost

13-7 © 2012 by McGraw-Hill All Rights Reserved

 Example: Two Alternative Breakeven Analysis
Make option is estimated to cost $18,000, have a life of 6
years, and have a $2000 salvage value, and annual VC 0.4.
Buy option annual VC is 1.5,
Breakeven
Perform a make/buy analysis where the common variable is X, AW, 1000 value of X
the number of units produced each year. $/year
AW relations are: Use a MARR of 15% per year
Answer
8 AWbuy
AWmake = -18,000(A/P,15%,6) +2,000(A/F,15%,6) – 0.4X 7
= -4528 - 0.4X AWmake
6

AWbuy = -1.5X 5

4
Solution: Equate AW relations, solve for X
3
-1.5X = -4528 - 0.4X
X = 4116 per year 2

If anticipated production > 4116, 1

select make alternative (lower variable cost)
0
If x is 1000
Make option is
If x is 6000 1 2 3 4 5
Make option is
= -4528 - 0.4*1000 = -4528 - 0.4*6000
= -4928 = -2128
X, 1000 units per year
Buy Option = -1.5*1000 Buy Option = -1.5*6000
=-1500 13-8
= -9000
Select make option
© 2012 by McGraw-Hill All Rights Reserved
Select buy option
 Example: Two Alternative Breakeven Analysis
The cost of renting and servicing a portable restroom is $7500 per year.
In one northeastern municipality, the parks director informed the city council that the cost of constructing
a permanent restroom is $218,000 and
the annual cost of maintaining it is $12,000.
He remarked that the rather high cost is due to the necessity to use expensive materials and construction
techniques that are tailored to minimize damage from vandalism that often occurs in unattended public
facilities. If the useful life of a permanent restroom is assumed to be 20 years,
how many portable restrooms could the city afford to rent each year and break even with the cost of one
permanent facility?
Let the interest rate be 6% per year.
Answer If x is 2
Rent option is = -7500*2
= -15,000
Let x = number of portables per year Cheaper than buy option –31,005
-7500 x (Rent option) = -218,000(A/P,6%,20) – 12,000 (Build option) So select rent option if x is 2

-7500 x = -218,000(0.08718) – 12,000

-7500 x = -31,005 If x is 6
Rent option is = -7500*6
x = 4.1 = -45,000
More expensive than buy option –
31,005
The city could afford four portable toilets per year So select buy option if x is11
6
 Summary of Important Points
Breakeven amount is a point of indifference to
accept or reject a project
One project breakeven: accept if quantity is > QBE

Two alternative breakeven: if level > breakeven,

select lower variable cost alternative (smaller slope)

13-16 © 2012 by McGraw-Hill All Rights Reserved