EGR 403 Presentation #3: Break Even Analysis

Breakeven Analysis
Part 1
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EGR 403 Capital Allocation Theory
Dr. Phillip R. Rosenkrantz
Industrial & Manufacturing Engineering Department
Cal Poly Pomona
EGR 403 - The Big Picture
• Framework: Accounting & Breakeven Analysis
• “Time-value of money” concepts - Ch. 3, 4
• Analysis methods
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Ch. 5 - Present Worth
Ch. 6 - Annual Worth
Ch. 7, 8 - Rate of Return (incremental analysis)
Ch. 9 - Benefit Cost Ratio & other techniques
• Refining the analysis
– Ch. 10, 11 - Depreciation & Taxes
– Ch. 12 - Replacement Analysis
EGR 403 - Cal Poly Pomona - SV3
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Introduction
• Break even (BE) analysis helps engineers
understand the “big picture”
• Knowing how your project or assignment
affects profitability can help you sell your
projects to upper management
• Understanding BE analysis illustrates the
value of engineers to the company
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Recall from the P & L Statement
• Fixed costs - do not vary (e.g., lease costs,
rent, insurance)
• Variable costs - vary with volume of
production (e.g., labor, materials, supplies,
rent, etc.) Overhead can also be applied
here as a variable expense or burden rate.
• Profit Equation Profit = Revenue - Expenses
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Breakeven Volume
• Total Variable Cost (VC) is a function of
volume (x) of units sold.
Total VC = Variable Cost/unit * x
• Total Cost = Fixed Cost + Total VC
• Revenue is also a function of units sold:
Revenue = Price/unit * x
• Breakeven Volume is the number of units
you need to sell so that:
Revenue = Total Cost
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Breakeven Volume (cont’d)
• Find x such that:
Price/unit * x = Fixed + VC/unit * x
• Therefore:
xBE = Fixed Cost / (Price/unit - VC/unit)
• If actual volume is < xBE , you have a loss
• If actual volume is > xBE , you have a profit
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Fixed Cost
Fixed cost is the the same, regardless of volume
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Variable Cost + Fixed Cost
Total Cost goes up with volume because Variable
Cost increases
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Total Revenue is based on volume and selling price/unit.
Where the Revenue and Total Cost lines intersect is the
Break Even (BE) Point. That volume is the BE Volume
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Profit
Above the BE point, the difference between the
Revenue and Total Cost lines represents profit
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Loss
If volume is below the BE point, the difference
between the lines represents a loss
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Break Even Analysis
• Collect financial and cost information to
determine fixed and variable costs
– Fixed costs
– Variable cost/unit (labor, materials, overhead)
• Estimate Selling Price per unit from
marketing analysis and market testing
• Determine BE volume and compare to
estimated sales
• If estimated sales volume is not above the
BE volume, make adjustments
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