1. EGR 312 - 231 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. EGR 312 - 232 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. EGR 312 - 233 Break-Even Analysis Cost Function – cont.: Total Cost = Fixed Cost + Variable Cost Cost presented as a function of production volume.

4. EGR 312 - 234 Break-Even Analysis Breakeven Point What is the breakeven point in terms of Production volume?

5. EGR 312 - 235 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 FC + VC*Q BE = Revenue *Q BE  Q BE = ________________

6. EGR 312 - 236 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. EGR 312 - 237 Break-Even Analysis In-Class Exercise You are an entrepreneur planning to enter the gourmet organic burger market. Your marketing consultant believes you can sell 150,000 burgers at $1.99 each. Fixed costs for the business are expected to total $140,000. In addition, variable costs will total about 0.97 per burger. How many burgers must you sell to break even? What if the price is $2.79? How many must you sell to break even?

8. EGR 312 - 238 Break-Even Analysis In-Class Exercise

9. EGR 312 - 239 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. EGR 312 - 2310 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) FC 1 + VC 1 *Q BE = FC 2 + VC 2 *Q BE _________________________ Q BE = ____________

11. EGR 312 - 2311 Break-Even 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 maintenance cost of $1200. What is the breakeven point in annual production volume? Assume a MARR of 10%.

12. EGR 312 - 2312 Break-Even 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 = _______________________________________ AW 1 = _______________________ AW 2 = -$15,000 (A/P, 10%,7) + $2000(A/F,10%,7) - $1200 –.8x AW 2 = _________________________________________ AW 2 = ________________________ x = ______

13. EGR 312 - 2313 Payback Period Analysis The payback period, n p, is the estimated time, usually in years, it will take for the estimated revenues and other economic benefits to recover the initial investment and a stated rate of return i. In other words, find n p that satisfies the following equation: Or if all end of year cash flows are equal, where NCF is the net cash flow in period t, and DP is the initial downpayment or cash flow at time 0

14. EGR 312 - 2314 Payback Period Analysis Example: A pharmaceutical company anticipates R&D cost of $1.5 Billion for the development of a new drug. In addition, production startup costs are estimated at $1.0 Billion. Annual marketing costs are expected to be $50 million, annual production costs are $100 million, and annual sales are expected to be $500 million. What is the payback period for an ROR of 10%? DP = $2,500 Million A = $350 million $2,500 = $350(P/A, 10%,n) (P/A,10%,n) = 7.14 n = ___________

15. EGR 312 - 2315 Payback Period Analysis Caution: Payback period does not necessarily indicate one alternative being preferable to another alternative. Example: Using ROR of 15% Machine 1Machine 2 DP = $12,000$8,000 Annual NCF = $3000$1000 (year 1-5) $3000 (year 6-14) Max Life714 (years)

16. EGR 312 - 2316 Payback Period Analysis Example: Machine 10 = -$12,000 + $3000(P/A,15%,n p ) n p = ___________ Machine 20 = -$8,000 + $1000(P/A,15%,5) + $3,000(P/A,15%,n p -5)(P/F,15%,5) n p = ______________ Using LCM of 14 years. PW 1 = _______________________________________ PW 2 = _______________________________________