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Introduction to Econmoics Lecture Three

The document discusses breakeven analysis, which determines the point at which total revenue equals total costs, allowing businesses to assess investment recovery and profitability. It outlines the components of costs, including fixed and variable costs, and provides examples of breakeven calculations for different scenarios, including a water company and amusement park rides. The analysis aids in decision-making by comparing alternatives based on their cost structures and breakeven points.

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3 views

Introduction to Econmoics Lecture Three

The document discusses breakeven analysis, which determines the point at which total revenue equals total costs, allowing businesses to assess investment recovery and profitability. It outlines the components of costs, including fixed and variable costs, and provides examples of breakeven calculations for different scenarios, including a water company and amusement park rides. The analysis aids in decision-making by comparing alternatives based on their cost structures and breakeven points.

Uploaded by

saramohamed0481
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© © All Rights Reserved
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Download as PPTX, PDF, TXT or read online on Scribd
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Introduction to Economics

Lecture Three :Breakeven Analysis

Dr. Eman alaa heikal

1
Part two : Economic Alternatives
selection : Breakeven Analysis
Break even analysis

Breakeven analysis determines the value of a parameter


or decision variable that makes two relations equal. For
example, breakeven analysis can determine the required
years of use to recover the initial investment and annual
operating costs.
There are many forms of breakeven analysis; some equate
PW or AW equivalence relations, some involve equating
revenue and cost relations, others may equate demand
and supply relations. However, they all have a common
approach, that is, to equate two relations, or to set their
difference equal to zero, and solve for the breakeven
value of one variable that makes the equation true.
The need to determine the breakeven value of a decision
variable without including the time value of money is
common.
Break even analysis
Costs, which may be linear or nonlinear, usually include two
components; fixed costs and variable costs, as indicated in
Figure1.
The fixed cost component is essentially constant for all
values of the variable, so it does not vary significantly over a
wide range of operating parameters. Even if no output is
produced, fixed costs are incurred at some threshold level .
A simple VC relation is vQ, where v is the variable cost per
unit and Q is the quantity. Variable costs change with output
level, workforce size, and many other parameters. It is
usually possible to decrease variable costs through
improvements in design, efficiency, automation, materials,
quality, safety, and sales volume.
When FC and VC are added, they form the total cost relation
TC. At some value of Q, the revenue and total cost relations
will intersect to identify the breakeven point Q BE. If Q > QBE,
there is a profit; but if Q< QBE, there is a loss. For linear R
and TC, the greater the quantity, the larger is the profit.
Break even analysis
Profit = Revenue – Total Cost = R - TC (1)

A closed-form solution for QBE may be derived when


revenue and total cost are linear functions of Q by
equating the relations, indicating a profit of zero.

R = TC
r Q =FC +VC = FC + v Q

where: r = revenue per unit


v = variable cost per unit

Solve for Q to obtain the breakeven quantity.

QBE = FC/ (r – v) - (2)


Break Even Point
Breakeven Analysis for One Alternative Example 1

Pure Life Water Company dispenses its product


Nature’s Pure Water via vending machines with most
current locations at food markets and pharmacy or
chemist stores. The average monthly fixed cost per
site is $900, while each gallon costs 18¢ to purify and
sells for 30¢.
(a) Determine the monthly sales volume needed to
break even.
Breakeven Analysis for One Alternative Example 2
Breakeven Analysis for One Alternative Example 2 Solution
Breakeven Analysis for One Alternative Example 2 Solution
Breakeven Analysis Between Two
Alternatives

1. Define the common variable and its dimensional


units.
2. Use AW or PW analysis to express the total cost of
each alternative as a function of the common
variable.
3. Equate the two relations and solve for the breakeven
value.
4. If the anticipated level is below the breakeven value,
select the alternative with the higher variable cost
(larger slope). If the level is above breakeven, select
the alternative with the lower variable cost.
Breakeven Analysis Between Two
Alternatives
Breakeven Analysis two Alternative Example

 Two new rides are being compared by a local amusement park in


terms of their annual operating costs. The two rides are assumed
to be able to generate the same level of revenue (and thus the
focus on costs). The Ride (A) has fixed costs of $10,000 per year
and variable costs of $2.50 per visitor. Ride (B) has fixed costs of
$4000 per year, and variable costs of $4 per visitor. Provide
answers to the following questions so the amusement park can
make the needed comparison.
(a) Mathematically determine the breakeven number of visitors per
year for the two rides to have equal annual costs.
(b) Develop a graph that illustrates the following:
(Note: Put visitors per year on the horizontal axis and costs on the
vertical axis.)
I) Accurate total cost lines for the two alternatives (show line,
slopes, and equations).
II) The breakeven point for the two rides in terms of number of
visitors.
III)The ranges of visitors per year where each alternative is
preferred.
Mathematical Solution for Two
Rides Example

FC(A) = $10,000 per year, VC(A) = $2.50 per visitor.

FC(B= $4000 per year, VC(A) = $4 per visitor.

(TC(A) = TC(B)

FC(A) + VC(A) = FC(B) + VC(B)

QBE = $4000 + $4 QBE $2.5 + $10,000

QBE = $(10,000 - 4,000)/$(4 - 2.5) = 6000/1.5 = 4000 visitors


Graphical Solution for Two Rides
Example
Thank You

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