SUBJECT Engineering Economics

SEMESTER 6th
SUBJECT CODE 19HS6ICEEM
FACULTY Dr. Vivek Bhandarkar V N
 Engineering Economics
Sub Code: 19HS6ICEEM CIE: 50
Hrs/ Week: 3 SEE: 50
Total Hrs: 50 Credits: 3

Module 4
Depreciation: Causes of Depreciation, Basic methods of computing
Depreciation charges: Straight line method of depreciation, Declining
balance method, Sum of year’s digits method and Sinking fund method.
Breakeven analysis: Introduction to breakeven analysis, calculation of
BEQ, BEP, Numerical Exercises.
Module 5
Replacement Analysis: Deterioration, obsolescence, inadequacy, Economic
life for cycle replacements, individual replacement, Numerical Exercises.
Costing: Elements of cost, Components of cost, preparation of cost sheet,
Numerical Exercises..
 Engineering Economics
Sub Code: 19HS6ICEEM CIE: 50
Hrs/ Week: 3 SEE: 50
Total Hrs: 50 Credits: 3

SELF-STUDY COMPONENT/ASSIGNMENT:
Unit-1: Law of demand and supply, Law of returns.
Unit-2: Comparison of assets with infinite lives.
Unit-3: Rate of return calculations by using ERR method.
Unit-4: Depreciation computations by using double declining balance method
Unit-5: Group replacement analysis.

TEXT BOOKS:
1. RIGGS J.L., Engineering economy, McGraw Hill, 2002
2. R PANEERSELVAM, Engineering Economics, PHI, Eastern Economy Edition,
2013.
3. NAIDU, BABU & RAJENDRA, Engineering Economy, New Age international
Publishers, 2006
4. M N Arora, Priyanka Katyal, Cost Accounting, Vikas Publishing house, 2nd
Revised Edition, 2016
 Engineering Economics
Sub Code: 19HS6ICEEM CIE: 50
Hrs/ Week: 3 SEE: 50
Total Hrs: 50 Credits: 3

REFERENCE BOOKS:
1. TARACHAND, Engineering Economy, 2000
2. TUESEN.G. Engineering Economy, PHI, 9th edition, 2009.
 Engineering Economics
Sub Code: 19HS6ICEEM CIE: 50
Hrs/ Week: 3 SEE: 50
Total Hrs: 50 Credits: 3

Course
outcome
CO1 Identify the importance and role of engineering economy in
investment decisions.
CO2 Understand the techniques of cash flows and interest calculations

CO3 Use present, annual & future worth comparisons for evaluation of
investment decisions
CO4 Analyze and determine the various rates of reruns for different
investments.
CO5 Plan a depreciation schedule for an asset and make break even
decisions
CO6 Recommend decisions on replacement of equipment and assess
the cost of product by considering the various elements of cost.
Module 4: Breakeven analysis:
Module 4: Breakeven analysis:
A breakeven analysis is used to determine how much sales
volume your business needs to start making a profit.

Breakeven analysis examines the short run relationship between

changes in volume and changes in total sales revenue, expenses
and net profit

The breakeven analysis is especially useful when you're

developing a pricing strategy, either as part of a marketing plan or
a business plan.

Also known as C-V-P analysis (Cost Volume Profit Analysis)

Module 4: Breakeven analysis:
Uses of Breakeven Analysis:
Breakeven analysis is an important tool in terms of short-term
planning and decision making

It looks at the relationship between costs, revenue, output levels

and profit

Short run decisions where C-V-P is used include choice of sales

mix, pricing policy etc.
Module 4: Breakeven analysis:
Decision making and Breakeven Analysis: Examples:
How many units must be sold to breakeven?

How many units must be sold to achieve a target profit?

Should a special order be accepted?

How will profits be affected if we introduce a new product or

service?
Module 4: Breakeven analysis:
Key Terminology: Breakeven Analysis
Fixed Cost : (FC) The sum of all costs required to produce the first
unit of a product. This amount does not vary as production
increases or decreases, until new capital expenditures are needed.

Variable Unit Cost : (VC) Costs that vary directly with the
production of one additional unit.

Material : VC Electricity – VC

Labour : VC

Transportation : VC

Plant Construction : FC , Equipment/Machine

Module 4: Breakeven analysis:
Key Terminology: Breakeven Analysis
Expected Unit Sales : Number of units of the product projected to
be sold over a specific period of time.

Unit Price : The amount of money charged to the customer for

each unit of a product or service.
Module 4: Breakeven analysis:
Key Terminology: Breakeven Analysis
Total Variable Cost (TVC): The product of expected unit sales
and variable unit cost.

TVC = Expected Unit Sales x Variable Unit Cost

= 100 x ₹10 = ₹1000

Total Cost (TC): The sum of the fixed cost and total variable
cost for any given level of production.

TC = Fixed Cost + Total Variable Cost

= 1000 + 100 x 10 = ₹2000

Module 4: Breakeven analysis:
Key Terminology: Breakeven Analysis
Total Revenue (TR): The product of expected unit sales and unit
price.

TR = Expected Unit Sales x Unit Price

= 100 x ₹25 = 2500

Profit (or Loss): The monetary gain (or loss) resulting from
revenues after subtracting all associated costs.

Profit / Loss = Total Revenue - Total Costs

= 2500 – 2000
= ₹ 500
Module 4: Breakeven analysis:
Key Terminology: Breakeven Analysis
BREAK EVEN POINT : Number of units that must be sold in
order to produce a profit of zero (but will recover all associated
costs).

Break Even Point (IN UNIT)=

Fixed Cost /(Selling. Price- Variable Unit Cost )

Break Even Point (in Rs)=

Fixed Cost/ (Selling Price-(Variable unit Cost x Units)

Module 4: Breakeven analysis:
Key Terminology: Breakeven Analysis

TR
A
n TC
n Profit
u
a BEP
l VC

C
o
s Loss
t
FC

Annual Volume
Module 4: Breakeven analysis:
USES OF BREAK EVEVN POINT

Helpful in deciding the minimum quantity of sales

Helpful in the determination of tender price

Helpful in examining effects upon organization’s profitability

Helpful in deciding about the substitution of new plants

Helpful in sales price and quantity

Helpful in determining marginal cost

Module 4: Breakeven analysis:
LIMITATIONS
• Break-even analysis is only a supply side (costs only) analysis, as it tells you
nothing about what sales are actually likely to be for the product at these various
prices.

• It assumes that fixed costs (FC) are constant

• It assumes average variable costs are constant per unit of output, at least in the
range of likely quantities of sales.

• It assumes that the quantity of goods produced is equal to the quantity of goods sold
(i.e., there is no change in the quantity of goods held in inventory at the beginning
of the period and the quantity of goods held in inventory at the end of the period.

• In multi-product companies, it assumes that the relative proportions of each product

sold and produced are constant.
Module 4: Breakeven analysis:
Example 1: . For a new product, the cost structures for producing at
three location's Mysore, Bangalore and Mangalore are given below:
Location Fixed cost / Year Variable cost/ unit
₹ ₹
Mysore 2,00,000 500
Bengaluru 4,00,000 300
Mangalore 8,00,000 100

The expected selling cost of the product is ₹ 1000 per unit. Find the
most economical location for a proposed volume of 1800 units per
year.
Module 4: Breakeven analysis:
Example 1: . Location Fixed cost / Year Variable cost/ unit
₹ ₹
Mysore 2,00,000 500
Bengaluru 4,00,000 300
Mangalore 8,00,000 100

Total Cost (TC) = FC + VC x Volume

TC(Mysore) = 2,00,000 + 500 x 2000 =₹ 12,00,000
TC(Bengaluru) = 10,00,000
TC( Mangalore) = 10,00,000

Total Cost (TC) = FC + VC x Volume

TC(Mysore) = 2,00,000 + 500 x 1800 =₹ 11,00,000
TC(Bengaluru) = ₹9,40,000
TC( Mangalore) = ₹ 9,80,000
Module 4: Breakeven analysis:
Example 1: .TC(Mysore) =12000 TC(Bengaluru) =10000 TC( Mangalore)
=10000 TR

16 TC (Mysore)

14
12 TC (Bangalore)
Annual Cost TC (Mangalore)
10
X 105(₹)
8
6 FC (Mangalore)

4
FC (Bangalore)
2
FC (Mysore)
500 1000 1500 2000 2500 3000

Annual volume (Number of units )

Profit = TR – TC
= ₹1000 x 1800 – 10,00,000 = ₹ 8,00,000
Module 4: Breakeven analysis:
Example 2: . For an industry trying to locate a unit at location A
would result in an annual fixed cost of ₹4,00,000 variable cost of ₹65
per unit and revenue of ₹75 per unit. For another location B under
consideration, the annual fixed costs are ₹7,50,000 variable costs are
₹45 per unit and revenue are ₹75 per unit. The estimated sales volume
is 27,000 units per year. Determine the most suitable location using
break even analysis.
BEP (A) = FC / ( Revenue – Variable cost)
= ₹ 4,00,000 / (75 – 65) = 40,000 units
BEP (B) = ₹ 7,50,000 / (75 – 45) = 25,000 units
Plant A: variable cost = 27000 x 65 = 17,55,000
Fixed cost = 4,00,000
Revenue : 27000 x 75 = 20,25,000
Plant B: variable cost = 27000 x 45 = 12,15,000
Fixed cost = 7,50,000
Revenue : 27000 x 75 = 20,25,000
Module 4: Breakeven analysis:
Example 2: .
BEP (A) = FC / ( Revenue – Variable cost)
= ₹ 4,00,000 / (75 – 65) = 40,000 units
BEP (B) = ₹ 7,50,000 / (75 – 45) = 25,000 units

Plant A: variable cost = 27000 x 65 = 17,55,000

Fixed cost = 4,00,000
Revenue : 27000 x 75 = 20,25,000

Profit (Loss) = TR – TC = - 1,30,000

Plant B: variable cost = 27000 x 45 = 12,15,000

Fixed cost = 7,50,000
Revenue : 27000 x 75 = 20,25,000
Profit (Loss) = TR – TC = 1,10,000
Module 4: Breakeven analysis:
Example 3: . A company wants to manufacture a new product for
expansion of its business. It has considered three location Bangalore,
Tumkur and Mysore. The fixed cost per annum and the vaiable cost per
unit at each locations are as follows:
Tumkur (T) Bangalore (B) Mysore (M)
Fixed Cost / Year 25 35 50
( ₹ in lakhs)
Variable ₹ 375 ₹ 320 ₹ 200
cost/Unit

The revenue per unit is ₹ 750. Determine the range of annual sales
volume for which each location becomes suitable. Also find the most
suitable location for a sales volume of 20,000 units.
Module 4: Breakeven analysis:
Example 3: . Tumkur (T) Bangalore (B) Mysore (M)
Fixed Cost / 25 35 50
Year
( ₹ in lakhs)
Variable ₹ 375 ₹ 320 ₹ 200
cost/Unit

TC = FC + VC x Volume
TC(T) = 25,00,000 + 375 x 20000 = ₹ 1,00,00,000

TC(B) = 35,00,000 + 320 x 20000 = ₹ 99,00,000

TC(M) = 50,00,000 + 200 x 20000 = ₹ 90,00,000

Module 4: Breakeven analysis:
Example 3: .
Module 4: Breakeven analysis:
Example 1: .TC(Mysore) =12000 TC(Bengaluru) =10000 TC( Mangalore)
=10000 TR

160

140 TC (T)
TC (B)
120
Annual Cost TC (M)
100
X Lakhs(₹)
80
60
40 FC (M)

20 FC (Bangalore)
FC(T)

5000 10000 15000 20000 25000 30000

Annual volume/Year (Number of units )
Module 4: Breakeven analysis:
Example 3: . A company manufacturing special screws is studying 4
alternative locations A, B and C for its new plant. The break up of
various costs for different locations are given below:
Locations A B C D
Plant Constructions (₹ in lakhs) 46 39 40 48
Labour per unit (₹) 1.0 1.4 1.2 1.3
Material & Equipment (₹ per 0.5 0.6 0.4 0.55
unit)
Electricity per year (₹) 35,000 30,000 33,000 28,000
Water (₹ Per year) 8000 7500 8000 7,000
Transportation ( ₹ per unit) 0.1 0.12 0.12 0.11
Taxes (₹ per year ) 35,000 32,000 60,000 40,000

The company wants to raise the finance from public bonds at 15% p.a.
interest. Determine the most economical location for output volume of
1,00,000 to 2,15,000 units per year.
Module 4: Breakeven analysis:
Example 3: .

Costs A B C D
Fixed cost (per year)
Electricity per year (₹) 35,000 30,000 33,000 28,000
Water (₹ Per year) 8000 7500 8000 7,000
Taxes (₹ per year ) 35,000 32,000 60,000 40,000
Bond interest @15% on plant 6,90,000 5,85,000 6,00,000 7,20,000
Total 7,68,000 6,54,500 7,01,000 7,95,000
Variable cost (per unit)
Labour per unit (₹) 1.0 1.4 1.2 1.3
Material & Equipment (₹ per unit) 0.5 0.6 0.4 0.55
Transportation ( ₹ per unit) 0.1 0.12 0.12 0.11
Total 1.6 2.12 1.72 1.96
Module 4: Breakeven analysis:
Example 3: .
Total cost : TC = FC + VC x V
Let us calculate the TC at a production volume of 1,00,000 units for all locations.
TC(A) = 7,68,000 + 1.6 x 1,00,000 = ₹ 9,28,000
TC(B) = 6,54,500 + 2.12 x 1,00,000= ₹ 8,66,500
TC(C) = 7,01,000 + 1.72 x 1,00,000 = ₹ 8,73,000
TC (D) = 7,95,000+ 1.96 x 1,00,000 = ₹ 9,91,000
 TR
Module 4: Breakeven analysis:
Example 3: .
TC (D)

13 TC (B)
TC (A)
12 TC (C)
11
Annual Cost
10
(₹ in lakhs )
9
8
7
6

50 100 150 200 250 300

Sales volume / year (x 1000)

Location B - Volume range of 1,00,000 to 1,25,000 units
Location C - Volume range of 1,25,000 to 2,15,000 units
Module 4: Breakeven analysis:
Example 4: . A consumer product manufacturing firm have these three
potential locations in Mysore, Mangalore and Bengaluru have the cost
structures shown below for a product expected to sell for Rs 260

Potential Locations Fixed cost (₹) Variable cost/ Year (₹)

Mysore 2,50,000 150

Mangalore 3,00,000 100
Bengaluru 5,00,000 50

i. Find the best economic location for an expected volume of 5000

units/year
ii. What is the expected profit if the selected option is used?
iii. For what output range, which location is best? Compare the result
graphically
Module 4: Breakeven analysis:
Example 4: .
i. Find the best economic location for an expected volume of 5000
units/year
TC(Mysore) = FC + VC x V = 250000 + 150 x 5000 = ₹ 10,00,000
TC(Mangalore ) = 3,00,000 +100 x 5000 = ₹ 8,00,000
TC (Bengaluru) = 5,00,000 + 50 x 5000 = ₹ 7,50,000

Bengaluru is the best location

ii. What is the expected profit if the selected option is used?
revenue = Selling price x Volume = ₹ 260 x 5,000 = ₹ 13,00,000/yr.

Profit = revenue – TC = ₹ 13,00,000 – 7,50,000 = ₹ 5,50,000

Module 4: Breakeven analysis:
Example 4: .
i. Find the best economic location for an expected volume of 5000 units/year
TC(Mysore) = ₹ 10,00,000 TC(Mangalore ) = ₹ 8,00,000
TC (Bengaluru) = ₹ 7,50,000 Bengaluru is the best location
ii. What is the expected profit if the selected option is used?
revenue = Selling price x Volume = ₹ 260 x 5,000 = ₹ 13,00,000/yr.
Profit = revenue – TC = ₹ 13,00,000 – 7,50,000 = ₹ 5,50,000
iii. For what output range, which location is best? Compare the result
graphically
Location Mysore: Break even point
= FC / (P – VC) = 250000 / (260-150) = 2272.7 = 2273 units
Location Mangalore: Break even point
= FC / (P – VC) = 300000 / (260-100) =1875 units
Location Bengaluru : Break even point
= FC / (P – VC) = 500000 / (260-50) = 2381 units
 13
Example 1:12.
11
10
9
8
7
6
Cost
5
X Lakhs(₹)
4
3
2
1

1000 2000 3000 4000 5000 6000

Annual volume/Year (Number of units )
Module 4: Breakeven analysis:
Example 5: . A computer company evaluating three cities for a new
plant to manufacture hardware components which will sell at Rs. 170/-
each. The economic portion of a plant location study shows the
following cost and market data
Cost Data Market Data
Cities A B C Volume Probability

Fixed costs/year in 300 200 150

1000Rs. 4500 0.1
5500 0.3
Variable cost/ unit 30 45 65 6500 0.6

i) On the basis of maximizing an economic expected value, graph the

plant location curve (Cost) using appropriate scale.
ii) Which city should be selected on the basis of given volume estimate(
From Graph)
iii) What is the break-even volume for the city selected?
Module 4: Breakeven analysis:
Example 5: .

Volume = 4500 x 0.1 + 5500 x 0.3 + 6500 x 0.6 = 6000 units 1 Marks

TC(A) = FC + VC x V = 300 x 1000 + 30 x 6000 = 4,80,000

TC(B) = 200 x 1000 + 45 x 6000 = 4,70,000
TC(C)= 150 x 1000 + 65 x 6000 = 5,40,000 3 Marks

iii. Breakeven volume for the city B

BEP = FC / (P-VC) = (200 x 1000) / ( 170 -45) = 1600 units 1 Mark

Graphical 3 Marks
Example 5: .

TR
10
9
8
7
6
TC (C)
Cost
5 TC (A)
X Lakhs(₹)
4 TC (B)

3
2
1
1600

1000 2000 3000 4000 5000 6000

Annual volume/Year (Number of units )
THANK YOU
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