Lecture 7-Break Even Analysis - UQU

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8/31/2020

Lecture 7

BREAK-EVEN ANALYSIS

Associate Professor. Mohamed El Ashhab


‫ ﻣﺣﻣﺩ ﺍﻟﺳﻳﺩ ﺍﻷﺷﻬﺏ‬.‫ﺩ‬

The Problem
• Proposed project
– Variable cost per Unit = 1 $
– Unit price = 3 $
– Building cost  = 1000 $/Month

• When is this project considered acceptable?

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Breakeven Quantity
Profit

Big Quantity

Breakeven Quantity

Small Quantity How can you calculate the Profit?

Loss
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Breakeven Analysis
• Break even is the point of production where are
firms revenue is equal to the total costs of
production

• Allows to decide if a business venture is financially


viable

• Looks at what will happen if level of production


changes

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Example
• Renting cost  = 1000 SR/Month
• Unit cost = 1 SR
• Unit price = 3 SR

Costs
• Total Cost for 1 unit    = 1000           + 1*1 = 1001
• Total Cost for 2 units  = 1000           + 1*2 = 1002
• Total Cost for 3 units  = 1000           + 1*3 = 1003
• Total Cost for Q units = Fixed Cost + Variable cost

• Total Cost for Q units = 1000 + 1*Q
• Total Cost for Q units = Fixed Cost + Variable cost per unit*Q

Example (Cont.)
Revenue
• Total Revenue for 1 unit    = 3 * 1 = 3
• Total Revenue for 2 units  = 3 * 2 = 6
• Total Revenue for 3 units  = 3 * 3 = 9

• Total Revenue for Q units = 3 * Q
• Total Revenue for Q units = Unit Price * Q

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Example (Cont.)
Contribution
• Unit Contribution = 3 ‐ 1 = 2
• Unit Contribution = Unit Price – Unit Cost
• Total Contribution = Unit Contribution * Quantity
• Total Contribution = (Unit Price – Unit Cost ) * Q

Profit
• Total Profit = Total Revenue ‐ Total Cost
 Total Revenue = Unit Price * Quantity
 Total Cost = Fixed Cost + Variable Cost

Fixed Cost (FC)
Fixed Costs (FC) do not change with volume of production 
• Building costs
Costs/Revenue • Minimum labor costs
• Capital recovery of equipment

1000 FC

Output/Sales
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Variable Cost (VC)
Variable Costs (VC) change with the volume of production
• Materials costs
Costs/Revenue • Labor costs
• Subcontractor costs
VC

1000 FC

Output/Sales
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Total Cost (TC)
The total costs therefore is the sum of FC+VC
Costs/Revenue TC
VC

1000 FC

Output/Sales
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Total Revenue (TR)
Total revenue = Unit price * Quantity sold
Costs/Revenue TR TC
VC

1000 FC

Output/Sales
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Total Revenue (TR)
Total revenue = Unit price * Quantity sold
Costs/Revenue TR TC

1000

Output/Sales
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Break‐Even Point
The Break‐even point occurs where total revenue equals total costs
Costs/Revenue TR TC

The Break‐even point 
Breakeven Price

1000

QBE = Breakeven Quantity Output/Sales


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Break‐Even Point

Typically TR are less 
than TC at beginning 
stages of production

1000

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Breakeven Point
• Total Revenue (TR) = P * Q 
• P = unit price
• Total Cost (TC) = FC + VC
• Variable Cost (VC) = v  * Q
• v = variable cost per unit
• At breakeven point: TR = TC
• P * QBE = FC + v * QBE
• P * QBE ‐ v * QBE = FC  QBE (P – v) = FC
• Breakeven Quantity(QBE ) = FC / (P – v)

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Contribution
• Can calculate contribution per unit or contribution for all
units of output

• Unit Contribution = P per unit – v per unit


• Total Contribution = Unit Contribution x Quantity
= Total Revenue – Variable Costs

• Profit = Total Revenue – Variable Costs – Fixed Costs


= Total Contribution - Fixed Costs

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Example 1
• Water vending machine: FC = $900 per month per 
site, p = 30¢ per gallon, and v = 18¢ per gallon. 
Find the Breakeven Quantity?
• Solution

• Must sell 7500 gallons per month per site to just 
breakeven Selling more means a profit is realized
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Example 2
• For Example 1, Determine profit at sales of Q = 
8,000 gallons/site

Solution:
• Profit = Total Revenue – Total cost 
= TR – (FC + VC)  
= 0.30*8000‐(900+0.18*8000) = 60 $
Or 
• Profit = Contribution – Fixed Cost
= (TR‐VC) – FC = 60$

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Changes in the business environment and BE

• If VC rise in value then break even output increases


• If VC fall in value break even output decreases
• If FC rise break even output increases
• If FC fall break even output falls
• If selling price increases break even output
decreases
• If selling price decreases break even output
increases

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Break‐Even Analysis
If the firm chose to set price higher than $2 (say $3) the TR curve would be steeper
Costs/Revenue TR (p = $3) TR (p = $2) TC
VC

FC

Q2 Q1 Output/Sales
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