BREAKEVEN ANALYSIS

Breakeven analysis is performed to

determine the value of a variable or
parameter of a project or alternative
that makes two elements equal, for
example, the sales volume that will
equate revenues and costs.
Breakeven Chart is a graphical
representation of breakeven analysis.
Breakeven Point is the quantity of
production in which the income is
equal to total cost. It is the
intersection of the income line and
the total cost line on the breakeven
chart.

Breakeven Analysis for a Single Project

Determination of the breakeven quantity QBE for one parameter or decision
variable.
Profit=RevenueTotal Cost
Profit=RTC

Profit=rQ(FC +VC )
A relation for the breakeven point may be derived when revenue and total
cost are linear functions of quantity Q by setting the relations for R and TC
equal to each other, indicating a profit of zero.
R=TC

rQ=FC +vQ
Solve for the breakeven quantity Q = QBE for linear R and TC functions.
QBE =

FC
r v

Where:

= Revenue or Income

TC

= Total Cost

FC = Fixed Cost
VC

= Variable Cost

= Revenue per Unit

= Variable Cost per Unit

= Parameter

QBE = Breakeven Point

Example:
Indira Industries is a major producer of diverter dampers used in the
gas turbine power industry to divert gas exhausts from the turbine to a side
stack, thus reducing the noise to acceptable levels for human environments.
Normal production level is 60 diverter systems per month, but due to
significantly improved economic conditions in Asia, production is at 72 per
month. The following information is available.
Fixed costs, FC

= $2.4 million per month

Variable cost per unit, v= $35,000

Revenue per unit, r

= $75,000

(a) How does the increased production level of 72 units per month compare
with the current breakeven point?
(b) What is the current profit level per month for the facility?
(c) What is the difference between the revenue and variable cost per damper
that is necessary to break even at a significantly reduced monthly
production level of 45 units, if fixed costs remain constant?
Solution:

(a) To determine the breakeven number of units.

QBE =

FC
2.400,000
=
r v 75,00035,000

QBE =60units per month

The figure is a plot of R and TC lines. The breakeven value is 60 damper
units. The increased production level of 72 units is above the breakeven
value.
(b) To estimate profit (in $1000 units) at Q = 72 units per month
Profit=R TC
Profit=rQ( FC +vQ )
Profit=( 75 ) (72 )[ 2400+35 ( 72 ) ]
Profit=$ 480
There is a profit of $480,000 per month currently.
(c) To determine the required difference
FC = $2.4 million. In $1000 units,
0=( rv )( 45 )2400
rv=

2400
45

rv=$ 53.33 per unit

Breakeven Analysis between

Two Alternatives
Breakeven analysis determines
the value of a common variable or
parameter between two alternatives.
Equating the two PW or AW relations
determines the breakeven point.
Selection of the alternative is

rv ,

with profit = 0, Q = 45, and

different depending upon two facts: slope of the variable cost curve and the
parameter value relative to the breakeven point.
The parameter can be the interest rate

i , first cost

P , annual

operating cost (AOC), or any parameter.

The following steps determine the breakeven point of the common
variable and the slope of a linear total cost relation.
1. Define the common variable and its dimensional units.
2. Develop the PW or AW relation for each alternative as a function of the
common variable.
3. Equate the two relations and solve for the breakeven value of the
variable.

If the anticipated level of the common variable is below the breakeven

value, select the alternative with the higher variable cost (larger slope).
If the level is above the breakeven point, select the alternative with the
lower variable cost.
Example:
A small aerospace company is evaluating two alternatives: the purchase
of an automatic feed machine and a manual feed machine for a finishing
process. The auto feed machine has an initial cost of $23,000, an estimated
salvage value of $4000, and a predicted life of 10 years. One person will
operate the machine at a rate of $12 per hour. The expected output is 8 tons
per
hour.
Annual
maintenance and operating
cost is expected to be
$3500.
The alternative manual
feed machine has a first cost
of $8000, no expected
salvage value, a 5-year life,
and an output of 6 tons per
hour.
However,
three
workers will be required at
$8 per hour each. The
machine will have an annual
maintenance and operation
cost of $1500. All projects

are expected to generate a return of 10% per year. How many tons per year
must be finished to justify the higher purchase cost of the auto feed
machine?
Solution:
Use the steps above to calculate the breakeven point between the two
alternatives.
1. Let x represent the number of tons per year.
2. For the auto feed machine, the annual variable cost is
Annual VC=

$ 12 1 hour x tons
hour 8 tons year

Annual VC=1.5 x
The VC is developed in dollars per year. The AW expression for the auto feed
machine is
AW auto =23,000

( AP , 10 , 10)+ 4,000( FA ,10 ,10)3,5001.5 x

AW auto =$69921.5 x
Similarly, the annual variable cost and AW for the manual feed machine are
Annual VC=

$8
1 hour x tons
( 3 operators )
hour
6 tons year

Annual VC=4 x

AW manual=8,000

( AP , 10 , 5)1,5004 x

AW auto =$3,6104 x
3. Equate the two cost relations and solve for x.
AW auto =AW manual
$69921.5 x =$3,6104 x
x=$ 1353tons per year

If the output is expected to exceed 1353 tons per year, purchase the
auto feed machine, since its VC slope of 1.5 is smaller than the manual feed
VC slope of 4.