MECHANICAL ENGINEERING

DEPARTMENT
2nd Year

Engineering Economy & Accounting

MEC210

Lecture #03
Break-Even Analysis

Prepared By: Dr. Sayed Ali Zayan 1st Term 2023/2024

Break-Even or Cost-Volume-Profit (CVP) Analysis
 Cost-volume-profit analysis is a technique to give the management an
overview of the volume of product which the company must sell so that no losses
are incurred and the sale volume at which the profit objective of the firm can be
achieved.
 CVP analysis can answer the following questions any organization is
interested in finding the answer of:

a) What might be the maximum volume of sales so that company does not
suffer any loss?

b) What is level of sales or sale volume to achieve the target of profit the firm
has set for itself?

c) How are the profits changed with change in price, cost and volume?

d) Should the company wind up its operations? If yes, at what point of time?
Break-Even or Cost-Volume-Profit (CVP) Analysis
 Break-even analysis is one form of the CVP analysis and so widely used that
both the terms CVP and Break-even are used interchangeably by many.
 Break-even is a special way of CVP analysis where the relationship between
costs incurred, volumes of products to be produced and profits achieved can be
presented in a simple and easy to understand manner.
A break-even analysis involves the study of following factors:
1. Fixed and variable costs:
Fixed costs are such which do not change with the volume of production and
volume of sales. Such costs include capital assets which the company uses for its
operations. Fixed costs depreciate over a period of time. Variable costs are such
costs which will change depending upon the volume of production. If the
production increases the cost of raw material expenditure on electricity, repair
and maintenance, taxes, etc., will increase and when the production decreases
these will decrease. Sometimes, a category of semi-variable costs is also talked
about. These are such costs which can be broken down to either fixed or variable.
Break-Even or Cost-Volume-Profit (CVP) Analysis
1. Sales price:

This is important as change in sales price will change the profit.

2. Contribution Margin:

It is defined as the excess of selling price over variable cost or

Contribution margin = Total sales — total variable cost
Break-Even Analysis is the analytical examination of the
mathematical relationship between costs and sales revenue, under a
given set of assumptions regarding the firm’s fixed costs and variable
costs.
Break-Even or Cost-Volume-Profit (CVP) Analysis
Assumptions:
Determining the break-even point presupposes ‫ يفترض‬the following:

a) Costs can be separated as fixed and variable costs.

b) Semi-variable costs are ignored and clubbed into either the fixed costs or the
variable costs.

c) Sales price of the product is constant and hence the curve of total revenue is a
linear curve.

d) Increase in variable costs is at a constant rate, hence the total cost curve is
linear in nature.

e) There is no change in technology during the time period under consideration.

f) There is no change in the labor efficiency during the time period under
consideration.
 Break-Even or Cost-Volume-Profit (CVP) Analysis
 Break-even analysis establishes a
relationship between revenue generated
and costs incurred with different
volumes.
 A point at which revenues and costs are
equal at a particular sales level is called
break-even point or in other words
break-even point may be defined as
"point of sales volume at which total
revenue generated is equal to total costs
incurred".
 It implies that beyond this point, the
company will make profit but below
this point the company will suffer
losses.
Break-Even or Cost-Volume-Profit (CVP) Analysis
Determining the Break-even Point:
Break-even Formula
F ( or FC or CF) = Fixed cost/period
V ( or v or Cv) = Variable cost per unit
P ( or s) = Selling price per unit
Q ( or N ) = Number of units produced and sold.
Then
Total revenue generated (TR or R) = Q x P
Total cost (TC or CT) = F + VQ
Profit = QP — (F + VQ)
At break-even point profit is zero or total revenue is equal to the total cost

Hence, QP = F + VQ
Break-Even or Cost-Volume-Profit (CVP) Analysis
or QP — VQ = F

or Q (P—V) = F
It can be seen from the above formula that the selling price per unit
should be greater than the variable cost per unit if the break-even point
has to be a positive or a rational number of units.
Break-Even or Cost-Volume-Profit (CVP) Analysis
Concept of Margin of safety
Margin of safety is expressed in terms of sales. It is the excess of actual sales over the
break-even sales volume.

Margin of safety = Actual sales — Break-even sales.

or

P/V or contribution ratio

In the above formula of break-even point in units and in $ or rupees (RS)
the denominator 1—(V/P) –or
Example 1:
Alpha Associates has the following details: Fixed cost ( F or FC) = $2,000,000,
Variable cost per unit (v) = $ 100, Selling price per unit (s or p) = $ 200 Find
a) The break-even sales quantity,
b) The break-even sales
c) If the actual production quantity is 60,000, find the profit.

Solution:
a)
FC 2,000,000
Break - even quantity = = = 20,000 units
s - v 200 - 100
b)
FC 2,000,000
Break − even sales = xs = x 200 = $4,000,000
s-v 200 − 100
c) The profit is:
Profit = Sales – (FC + v x N)
= 60,000 x 200 – (2,000,000 + 100 x 60,000) = 12,000,000 – 8,000,000 = $ 4,000,000
Example 2:
Following information is available for ABC Ltd:
Total fixed costs = Rs . 8000
Total variable costs = Rs. 12000
Total sales = Rs. 25000
Units sold = Rs. 4000
Calculate the following:
(a) Contribution
(b) B/E in units
(c) Profit
(d) Margin of safety
(e) Volume of sales to earn a profit of Rs. 12000.
Solution:
(a) Contribution = Total sales - Total variable costs

= 25000 - 12000 = Rs. 13000 or contribution/units

(c) Profit = Total sales - Total costs = 25000 - (8000 + 12000) = Rs. 5000

(d) Margin of safety = Total sales - B/E sales = 25000 -15384.6 = Rs. 9615.4
Break-even chart or cost-volume graph
 We have calculated the break-even point using mathematical formula. It is also
possible to depict it in the form of graph or chart. It can help us in visualizing
the extent of profit or loss for different levels of sales at a glance. In other
words, it is a pictorial view of the relationship between costs, volumes of sales
and profits incurred or loss suffered. In graph the point at which total cost line
and total sales line (representing revenue) intersect, is called the break-even
point.

Drawing of Break-even Graph

 Let horizontal axis indicate the output volumes and vertical axis the revenue
generated. The changes in output can be shown as changes in costs, revenue
and profit. Total cost and total revenue curves are drawn as linear straight
profits. Total cost and total revenue curves are drawn as linear lines as per the
assumptions made. Linear total revenue curve means as the volume of sale or
output increases the revenue keeps increasing. Similarly, linear total cost curve
is because of the assumption that variable costs change at constant rate.
Break-even chart or cost-volume graph
Break-Even chart
Break Even Analysis to Compare Two Methods of Production:

To find the break even quantity, we set the two cost

functions equal and solve for N, Figure.
Example 3:
A small metal-machining company produces parts according to
customer order. One particular part is frequently ordered in batch
sizes of 15—150 units. The company has determined that the part can
be produced on three different machine tools: Ml, M2, M3. An
economic analysis reveals the following data:

a) By either a graphical or analytical approach, determine the most

economical machine(s) to use for order sizes from 0—150 units.
b) For an order size of 75 units, what is the minimum total cost for
machining the order?
Solution:
Breakeven Point When Price is dependent of Demand
The total revenue, TR, that will result from a business venture during a given
period is the product of the selling price per unit, p, and the number of units sold,
D. Thus,
TR = price × demand = p · D.
Where
p = the selling price per unit and
D = Demand of the product
If the relationship between price and demand
as given in the following equation:

a is the intercept on the price axis and −b is the slope.

Is used, then
Breakeven Point When Price is dependent of Demand
The relationship between total revenue and demand may be represented by the curve
shown in Figure.
the demand, ˆD, that will produce maximum
total revenue can be obtained by solving

Thus,

Fixed costs remain constant over a wide range of activities,

but variable costs vary in total with the volume of output.
Thus, at any demand D, total cost is CT = CF + CV,
where CF and CV denote fixed and variable costs, respectively. For the linear
relationship assumed here, CV = cv · D,
where cv is the variable cost per unit.
Breakeven Point When Price is dependent of Demand
When total revenue, as depicted in previous figure, and total cost, as given by above
equations, are combined, the typical results as a function of demand are depicted in
Figure.
Breakeven Point When Price is dependent of Demand
At breakeven point D'1, total revenue is equal to total cost, and an increase in
demand will result in a profit for the operation. Then at optimal demand, D∗,
profit is maximized. At breakeven point D'2, total revenue and total cost are
again equal, but additional volume will result in an operating loss instead of a
profit. Obviously, the conditions for which breakeven and maximum profit
occur are our primary interest. First, at any volume (demand), D,

In order for a profit to occur, based on above equation, and to achieve the typical results
depicted in above figure, two conditions must be met:
1)(a−cv) > 0; that is, the price per unit that will result in no demand has to be greater than the
variable cost per unit. (This avoids negative demand.)
2)Total revenue (TR) must exceed total cost (CT) for the period involved.
Breakeven Point When Price is dependent of Demand
If these conditions are met, we can find the optimal demand at which maximum
profit will occur by taking the first derivative of above equation with respect to D
and setting it equal to zero:

The optimal value of D that maximizes profit is

To ensure that we have maximized profit (rather than minimized it), the sign of the
second derivative must be negative. Checking this, we find that

which will be negative for b > 0 (as specified earlier).

Breakeven Point When Price is dependent of Demand
An economic breakeven point for an operation occurs when total revenue equals
total cost. Then for total revenue and total cost, as used in the development of
pervious equations and at any demand D,

Because above equation is a quadratic equation with one unknown (D), we

can solve for the breakeven points D'1 and D'2 (the roots of the equation):
Example 4:
A company produces an electronic timing switch that is used in
consumer and commercial products. The fixed cost is $73,000 per
month, and the variable cost is $83 per unit. The selling price per
unit is

p = $180 − 0.02(D),
a) Determine the optimal volume for this product and confirm that
a profit occurs (instead of a loss) at this demand.

b) Find the volumes at which breakeven occurs; that is, what is the
range of profitable demand?
Solution:
a)

($180 − $83) = $97, which is greater than 0.

and is (total revenue − total cost) > 0 for D∗ = 2,425 units per month?

[$180(2,425) − 0.02(2,425)2] − [$73,000 + $83(2,425)] = $44,612

A demand of D∗ = 2,425 units per month results in a maximum profit of $44,612 per
month. Notice that the second derivative is negative (−0.04).

b) Total revenue = total cost (breakeven point)

Solution:
Then,

Thus, the range of profitable demand is 932–3,918 units per

month.