Breakeven Analysis for a Single

Project
Instructor
Dr. Syed Amir Iqbal.
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.
A breakeven study is performed for two alternatives to
determine when either alternative is equally acceptable,
for example, the replacement value of the defender in a
replacement study that makes the challenger an equally
good choice.
Breakeven analysis is commonly applied in make-or-buy
decisions when corporations and businesses must decide
upon the source for manufactured components, services of
all kinds, etc.
Breakeven studies use estimates that are considered to be certain;
that is, if the estimated values are expected to vary enough to
possibly change the outcome, another breakeven study is necessary
using different estimates.
This leads to the observation that breakeven analysis is a part of the
larger efforts of sensitivity analysis.
Our target is to concentrate on the determination of the breakeven
quantity for a decision variable. For example, the variable may be a
design element to minimize cost, or the production level needed to
realize revenues that exceed costs by 10%. This quantity, called the
breakeven point Q
BE
is determined using relations for revenue and
cost at different values of the variable Q. The size of Q may be
expressed in units per year, percentage of capacity, hours per
month, and many other dimensions.
Breakeven analysis
Figure (a) presents different shapes of a revenue relation identified as R. A linear
revenue relation is commonly assumed, but a nonlinear relation is often more
realistic. It can model an increasing per unit revenue with larger volumes (curve 1
in Figure (a), or a decreasing per unit price that usually prevails at higher quantities
(curve 2).
Costs, which may be linear or nonlinear, usually include two components fixed and
variable-as indicated in Figure (b).
Breakeven Analysis
Costs
Fixed costs (FC). Includes costs such as buildings, insurance, fixed overhead,
some minimum level of labor, equipment capital recovery, and information
systems.
Variable costs (VC). Includes costs such as direct labor, materials, indirect
costs, contractors, marketing, advertisement, and warranty.
The fixed cost component is essentially constant for all values of the variable,
so it does not vary for a large range of operating parameters, such as
production level or workforce size. Even if no units are produced, fixed costs
are incurred at some threshold level. Of course, this situation cannot last long
before the plant must shut down to reduce fixed costs.
Fixed costs are reduced through improved equipment, information systems
and workforce utilization, less costly fringe benefit packages, subcontracting
specific functions, and so on.
Variable costs change with production level, workforce size, and other
parameters. It is usually possible to decrease variable costs through better
product design, manufacturing efficiency, improved quality and safety, and
higher sales volume.
Breakeven Analysis
Costs
At a specific but unknown value Q of the decision variable, the revenue and
total cost relations will intersect to identify the breakeven point Q
BE
(Figure). If Q
> Q
BE
there is a predictable profit; but if Q < Q
BE
there is a loss. For linear models
of Rand VC, the greater the quantity, the larger the profit. Profit is calculated as:


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.


where r = revenue per unit
v = variable cost per unit
The breakeven graph is an important management tool because it is easy to
understand and may be used in decision making and analysis in a variety of
ways.
Breakeven Analysis
Costs
Of course, no static R and TC
relations-linear or nonlinear- are
able to estimate exactly the
revenue and cost amounts over an
extended period of time. But the
breakeven point is an excellent
target for planning purposes.

Effect on the break even
point when the variable
cost per unit is reduced.
Breakeven Analysis
Costs