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Engineering Economy: Lesson 4 - Break Even Analysis

The document discusses break-even analysis and profit-volume ratio analysis. It defines key terms like break-even point, contribution, margin of safety, and profit-volume ratio. The document also includes an example problem demonstrating how to calculate break-even quantity, sales, contribution, margin of safety, and profit using given sales, fixed costs, and variable cost data. Formulas for calculating break-even point using profit-volume ratio and margin of safety using contribution are also provided.

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Owene Miles Aguinaldo
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616 views20 pages

Engineering Economy: Lesson 4 - Break Even Analysis

The document discusses break-even analysis and profit-volume ratio analysis. It defines key terms like break-even point, contribution, margin of safety, and profit-volume ratio. The document also includes an example problem demonstrating how to calculate break-even quantity, sales, contribution, margin of safety, and profit using given sales, fixed costs, and variable cost data. Formulas for calculating break-even point using profit-volume ratio and margin of safety using contribution are also provided.

Uploaded by

Owene Miles Aguinaldo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ENGINEERING

ECONOMY
LESSON 4 – BREAK EVEN ANALYSIS
BREAK-EVEN ANALYSIS
The main objective of break-even analysis is to find the cut-off production
volume from where a firm will make profit. Let;

s = selling price per unit


v = variable cost per unit
FC = fixed cost per period
Q = volume of production

The total sales revenue (S) of the firm is given by the following formula:

= *
BREAK-EVEN ANALYSIS
The total cost of the firm for a given production volume is given as

= +
=v* +
BREAK-EVEN ANALYSIS
 The linear plots of the above two equations are shown in Figure below
 The intersection point of the total sales revenue line and the total cost
line
is called the break-even point.
 The corresponding volume of production on the X-axis is known as the
break-even sales quantity.
 At the intersection point, the total cost is equal to the total revenue. This
point is also called the no-loss or no-gain situation.
 For any production quantity which is less than the break-even quantity,
the total cost is more than the total revenue. Hence, the firm will be
making loss.
BREAK-EVEN ANALYSIS
BREAK-EVEN ANALYSIS
Profit = Sales – ( Fixed cost + Variable costs)
= (s * Q) – (FC + v * Q)

Break – even quantity = Fixed Cost / (Selling price per unit – Variable cost per unit)
= FC / (S – V)

Break – even sales = [Fixed Cost / (Selling price per unit – Variable cost per unit)](s)
= [FC / (S – V)]s
BREAK-EVEN ANALYSIS
The contribution is the difference between the sales and the variable costs.
The margin of safety (M.S.) is the sales over and above the break-even sales.

Contribution = Sales – Variable Cost

Margin of Safety (M.S.) = Actual sales – Break even sales


= (profit/contribution)(sales)
BREAK-EVEN ANALYSIS
The contribution is the difference between the sales and the variable costs.
The margin of safety (M.S.) is the sales over and above the break-even sales.

Contribution = Sales – Variable Cost

Margin of Safety (M.S.) = Actual sales – Break even sales


= (profit/contribution)(sales)
BREAK-EVEN ANALYSIS
EXAMPLE:
An engineering consulting firm measures its output in a standard service hour unit, which is
a function of the personnel grade levels in the professional staff. The variable cost is ₱3,100
per standard service hour. The charge-out rate is ₱4,278 per hour. The maximum output of
the firm is 160,000 hours per year, and its fixed cost is ₱101,200,000 per year. For this firm,
FIND :
(a) The break=even quantity and its percentage on maximum output per year?
(b) The break-even sales
(c) If the actual production quantity is 130,000 hours. Find. (1) Contribution and (2) Margin
of Safety
(d) what is the percentage of break-even quantity over maximum output of firm if fixed
costs are reduced 10%; if variable cost per hour is reduced 10%; and if the selling price per
unit is increased by 10%.
BREAK-EVEN ANALYSIS
SOLUTION:

s = ₱4,278/hour

v = ₱3,100/hour

FC = ₱101,200,000

M = 160,000 hours

A. Break – even quantity = Fixed Cost / (Selling price per unit – Variable cost per unit)

= FC / (s – v)

= (₱101,200,000)/( ₱4,278/hour - ₱3,100/hour)

= 85,908.32 hours

% of total capacity = [(85,908.32 hours) / ( 160,000 hours )] x 100

= 53.69 %
BREAK-EVEN ANALYSIS
B. Break – even sales = [Fixed Cost / (Selling price per unit – Variable cost per unit)](Selling Price per unit)
= [FC / (S – V)]s
=[ (₱101,200,000)/( ₱4,278/hour - ₱3,100/hour)] x ₱4,278/hour
= ₱ 367,515,793.00

C. Q = 130,000 hours
(1) Contribution = Sales – Variable Cost
= ( s * Q ) – ( v * Q)
= (₱4,278/hour * 130,000 hours) – ( ₱3,100/hour * 130,000 hours)
= ₱153,140,000.00
BREAK-EVEN ANALYSIS
(2) Margin of Safety (M.S.) = Actual sales – Break even sales 1st eq’n

= (profit/contribution)(sales) 2nd eq’n

Using 1st eqn = {(₱4,278/hour * 130,000 hours) - [ (₱101,200,000 / ₱4,278/hour -


₱3,100/hour) * ₱4,278/hour ]}

= ₱ 556,140,000 - ₱367,515,793

= ₱ 188,624,207
BREAK-EVEN ANALYSIS
Using 2nd eqn
Profit = Sales – ( Fixed cost + Variable costs)
= (s * Q) – (FC + v * Q)
= (₱4,278/hour * 130,000 hours) – (₱101,200,000 + ₱3,100/hour *
130,000 hours)
= ₱ 556,140,000 – ₱ 504,200,000
= ₱ 51,940,000

M.S. = (₱ 51,940,000 / ₱153,140,000 ) x ₱ 556,140,000


= 0.33916677 x ₱ 556,140,000

= ₱ 188,624,207
BREAK-EVEN ANALYSIS
SEATWORK : SOLVE LETTER D
PROFIT/VOLUME RATIO (P/V RATIO)
The Profit Volume (P/V) Ratio is the measurement of the rate of change of
profit due to change in volume of sales. It is one of the important ratios for
computing profitability as it indicates contribution earned with respect of
sales.

P/V ratio = Contribution/Sales


= (Sales – Variable Cost) / Sales
PROFIT/VOLUME RATIO (P/V RATIO)
The relationship between Break Even Point (BEP) and P/V ratio is as follows:

BEP = (Fixed Cost / P/V Ratio)

The following formula helps us find the Margin of Safety (M.S.) using the P/V ratio:

M.S. = (Profit / P/V Ratio)


PROFIT/VOLUME RATIO (P/V RATIO)
EXAMPLE :
Consider the following data of a company:

Sales = ₱120,000
Fixed cost = ₱25,000
Variable cost = ₱45,000
Find the following:
(a) Contribution
(b) Profit
(c) BEP
(d) M.S.
PROFIT/VOLUME RATIO (P/V RATIO)
a. Contribution = Sales – Variable Cost

= ₱120,000 - ₱45,000

= ₱75,000

b. Profit = Sales – ( Fixed Cost + Variable Cost )

= ₱120,000 – (₱25,000 + ₱45,000)

= ₱50,000
PROFIT/VOLUME RATIO (P/V RATIO)
c. BEP = Fixed Cost / P/V Ratio

P/V Ratio = Contribution / Sales

= ₱75,000 / ₱120,000

= 0.625 or 62.50%

BEP = ₱25,000 / 0.625

= ₱40,000
PROFIT/VOLUME RATIO (P/V RATIO)

d. M.S. = Profit / P/V Ratio


= ₱50,000 / 0.625
= ₱80,000

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