1. Break-Even Analysis Break-even Analysis – performed to determine the value of a variable that makes two elements equal. In economic terms: determining a parameter such that revenue equals cost. The study parameter might be: Production Volume Percentage of capacity Labor rate Replacement cost Etc.

2. Break-Even Analysis Cost Function: Fixed Cost (FC) – that cost which does not vary based on production volume. Includes building, insurance, fixed overhead (e.g. Engineering staff), equipment recovery cost, information systems, etc. Variable Cost (VC) – that cost which varies as production volume varies. Includes direct labor, materials, warranty, utilities (power consumption), marketing, etc.

3. Break-Even Analysis Cost Function – cont.: Total Cost = Fixed Cost + Variable Cost Cost presented as a function of production volume.

4. Break-Even Analysis Breakeven Point What is the breakeven point in terms of Production volume?

5. Break-Even Analysis Breakeven Point –cont. FC = $10,000 VC = $5000(per 1000 units) Revenue = $8000(per 1000 units) Let Q = Production Volume (000s) Q BE = Production Volume (000s) at the Breakeven point Total Cost = Revenue $10,000 + $5000*Q BE = $8000 *Q BE Q BE = 10,000/3000 = 3.333 (000s) = 3333 units

6. Break-Even Analysis Sensitivity Analysis Impact of reducing or increasing one factor while holding the other constant. Example: What is the Q BE if VC varies from $4000 to $6000?

7. Break-Even Analysis In-Class Exercise Your starting salary upon graduation is $50,000 / year. The state takes 6%, the Feds take 21%, 7.5% Social Security and Medicare takes another 3%. Using good tax advice, you are able to reduce your total taxes by 20%. How many months do you work for free (in other words, what is the breakeven point in months between taxes and salary)?

8. Break-Even Analysis In-Class Exercise

9. Break-Even Analysis Breakeven analysis between two alternatives: If demand for the product is 1,000 units a month, which alternative should you choose? 3,000 units a month?

10. Break-Even Analysis Breakeven analysis between two alternatives: What is the breakeven point? FC(1) = $10,000 FC(2) = $15,000 VC(1) = $5000 / (000s units) VC(2) = $2000 / (000s units) $10,000 + $5000*Q BE = $15,000 + $2000* Q BE $3000 * Q BE = $5000 Q BE = 1.66 (000s units)

11. Break-Even Analysis Breakeven analysis AW approach: Two alternatives exist for a machining process. Alternative 1 has an initial cost of $10,000 and a salvage value of $1000 after 5 years. Alternative 1 also has a variable cost of $1/unit of product produced and an annual maintenance of $1000. Alternative 2 has an initial cost of $15,000 and a salvage value of $2,000 after 7 years. Alternative 2 also has a variable cost of $0.80/unit of product produced and an annual maint. cost of $1200. What is the breakeven point in annual production volume? Assume a MARR of 10%.

12. Break-Even Analysis Breakeven analysis AW approach: Let x = annual production volume. AW 1 = -$10,000 (A/P, 10%,5) + $1000(A/F,10%,5) - $1000 – 1.0x AW 1 = -$10,000(.2638) + $1000(.1638) - $1000 -$1.0x AW 1 = -$3474.2 - $1.0x AW 2 = -$15,000 (A/P, 10%,7) + $2000(A/F,10%,7) - $1200 –.8x AW 2 = -$15,000(.20541) + $2000(.10541) - $1200 - $.8x AW 2 = -$4070.3 - $.8x -$3474.2 - $1.0x = -$4070.3 - $.8x x = 2980.5