Break-Even Analysis
ENGINEERING COSTS
CONCEPTS
AND
COST ESTIMATING
MODELS
▪ Engineering Economy, William G. Sullivan, Elin M. Wicks, C. Patrick Koelling;
Chapter 2 & 3
▪ Engineering Economic Analysis, Donald G. Newnan, Ted G. Eschenbach, Jermo P.
Lavelle; Chapter 2
Break-Even (B.E) Analysis
A break-even analysis is a financial tool which helps
to determine the stage at which the company, or a
product, will be profitable.
In other words, it is a financial calculation that
determines when a business will be able to cover all its
costs (particularly Fixed Cost) and start making profits.
B.E Quantity (output level) is the relationship between
Total Revenue and Total Cost and used as decision
making tool.
Total Revenue = Price x Quantity Sold
TR = PQ
Total Cost = Fixed Cost + Variable Cost
TC = FC + VQ
Variable Cost = Directs + Indirects
Price = Directs + Indirects + Profit
Price = VQ + Profit
Profit = Total Revenue – Total Cost
Profit = TR – TC
3
B.E Quantity is the output level where:
Total Revenue = Total Cost
i.e No Profit No Loss condition
Above this output level : Below this output level :
Total Revenue > Total Cost = Total Revenue < Total Cost =
Profit Loss
Where;
TR = TC FC QBE = Break Even Output Level
PQ = FC + QB.E = FC = Fixed Cost
VQ (P − V ) P = Per Unit Price
V = Per Unit Variable Cost
(P-V) = Profit Margin 4
Break-Even Analysis (Graphical)
Type equation here.
5
Cost, Revenue
Break-Even Analysis
(Graphical)
Short Term
Output
6
Change in Break-Even Output level …..
If price increases (P-V) increases
QBE decreases
If per unit Variable cost decreases (P-V) increases
QBE decreases
If per unit Variable cost increases (P-V) decreases
QBE increases
7
An Engineering consultant firm measures its output in a standard
service hour unit. The variable cost is $62 per standard service
hour. The charge-out rate (i.e., selling price) is $85.56 per hour.
The maximum output of the firm is 160,000 hours per year, and
its fixed cost is $2,024,000 per year. For this firm:
(a) What is the breakeven point in standard service hours and in
percentage of total capacity?
(b) What is the percentage reduction in breakeven (sensitivity
analysis) if:
1. fixed costs are reduced 10%;
2. if variable cost per hour is reduced 10%;
3. if the selling price per unit is increased by 10%. 8
Solution:
Output unit = service hours
Per unit variable cost = $62/service hrs
Per unit selling price = $85.56/service hrs
Maximum output (capacity) = 160,000 hrs
Fixed cost = $2,024,000/yr.
FC 2,024,000
(a) Q BE = = = 𝟖𝟓, 𝟗𝟎𝟖 𝐬𝐞𝐫𝐯𝐢𝐜𝐞 𝐡𝐫𝐬
(P−V) (85.56−62)
BE service hours in percentage of total capacity =
85,908ൗ = 𝟓𝟑. 𝟕%
160,000 9
Solution:
(b)
(i) FC decrease by 10% → New FC = $1,821,600
New FC
Q BE = = 𝟕𝟕, 𝟑𝟏𝟕 𝐬𝐞𝐫𝐯𝐢𝐜𝐞 𝐡𝐫𝐬
(P−V)
BE service hours in percentage of total capacity = 48%
(ii) VC decrease by 10% → New VC = $55.8
(complete this question)
10
A company produces circuit boards used to update
outdated computer equipment. The fixed cost is
$42,000 per month, and the variable cost is $53 per
circuit board. The selling price per unit is p = $150
−0.02Q. Maximum output of the plant is 4,000 units
per month.
1. At what output level breakeven occurs?
2. Determine profit maximization level of output.
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Solution:
FC = $42,000
V = $53/circuit board
P = 150 – 0.02Q
1) Break-Even output level: TR = TC
150Q – 0.02Q2 = 42,000 + 53Q
Q1 =– 480
97Q 0.02Q2 – 42,000 = 0
circuits boards
Q2 = 4369 circuits boards
Break-even quantities
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2) Profit Maximization Level of Output:
As Profit = Total Revenue – Total Cost = TR – TC
And TR = PQ = (150 – 0.02Q)Q = 150Q – 0.02Q2
TC = FC + VC = 42,000 + 53Q therefore
Profit = (150Q – 0.02Q2) – (42,000 + 53Q) = 97Q – 0.02Q2 – 42,000
In order to determine ‘Profit maximization level of output’,
differentiate profit function w.r.t. Q and equate it to zero :
Profit = 97Q – 0.02Q2 – 42,000 Q = 2425 circuit boards
𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 Profit Maximization
= 97 – 0.04Q = 0
𝑑𝑄
level of output
13
The total cost function of a firm is TC = Q3/3 –
5Q2 + 28Q + 10. A tax at the rate of $2 per unit of
output is imposed and the producer adds it to his
cost. If the market demand function is given by p =
2530 – 5Q, where p is the price per unit of output,
find the profit maximization level of output.
Answer:
Profit Maximization Level of Output (Q) = 50 units
The manufacturing cost of an item consists
of $1,600 as overhead, material cost is $30 per
item and worker cost is (Q2 /100) for Q items
produced. Find how many items be produced to
have the minimum average cost.
Answer:
Minimum Average Cost Level of Output (Q) = 400
units
