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You are on page 1of 5

Hello Class. Welcome to the final chapter of this course. I hope that you enjoyed the

course and have learned some new things that can apply to your future work and to

your personal finances. In any good economic study we start with the definitions so that

we are all on the same page.

We start with breakeven analysis. Breakeven analysis can be performed for one project

analysis or for two alternatives. For a single project, it determines a parameter value

that makes revenue equal to cost .For two alternatives the breakeven is when they are

equally acceptable bases on a calculated of one parameter common to both

alternatives. Make or buy decisions for contractor services, manufactured components,

or international contracts are routinely based upon a breakeven analysis.

(PW, AW, ROR or B/C. It answers the question What If?.

Payback period is a good technique to initially determine. The technique is initially used

to determine if a procject is financially acceptable. It determines if the amount of time

necessary on a project to do two things, develop enough cash flow to recover the initial

investment and to meet or eceed the MARR.

Figure 8.1, page 208 of your text, shows some comparisons When we do breakeven

analysis we will often have to develop a graphical representation of the data.

Fixed Costs (FC) includes costs such a buildings, insurance, fixed overhead, and

information systems. These costs do not vary with the production rates and are usually

linear. Fixed costs are those that you would have if no product was produced.

Variable Costs (VC) are cost that increase or decrease with amount of production. They

include direct labor, subcontractor materials, advertising, and marketing to name a few.

These costs are usually directly related to the manufacturing of a product. The more

product, the more hours that are required to produce them. Variable costs can be

shown mathematically by the equation vQ, where v stands for the variabke cost per unit

and Q is the number of units produced.

FC + VC = TC (total cost)

When R an TC are linear functions and R = TC.This is the breakeven point, Figure 8.2

R = TC we can substitute for R rQ and we can substitute for TC, VC + FC

Q BE = FCrv Breakeven equals FC divided by revenue cost per unit minus variable cost

per unit

Figure 8.2 shows the relation < when we have linear function of Total cost to Revenue.

breakevens.

Figure 8.3 shows how nonlinear functions of TC and R related. Notice we now two

breakeven points, but only one point where we maximize profit.

Problem 8.1

To solve this problem we first calculate the breakeven point at 7500 gallons.

FC 900

Thus Q = rv = .3 .18 = 7500 gallons

However when we do the second part of the equation the first answer plays no part as

we now have two different breaks in the price per gallon

So revenues now require you to add the revenue at 5000 gallon at .30 per gallon to

some unknown quantity Q at .2 a gallon and costs the fixed cost of $900 plus .18 times

the first 5000 gallons plus Q at .18 per gallon

gallons This means that we need to add 15,000 gallons, this is the amount above the

5000 gallons where we reach break even. On the graph this is $4500

Another equation that you can use for breakeven analysis is a revenue cost equation

TC FC+vQ FC

Therefore C = Q = Q = Q +v

There is a good example of the use of PW, FW and AW for use in breakeven analysis

on page 213 of your book. Please read it.

Breakeven used to determine the value of aq parameter that is common to two

alternatives. Breakeven analysis usually involved revenue or cost variables common to

both alternatives. It is common to find the breakeven value by equating PW or AW

equivalence relations. The AW is preferred when the variable units are expressed on a

yearly basis or when alternatives have unequal lives.

2. Use the 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 breakeven value

4. The select guideline is based on the selected level of the common variable and

the size of the variable cost.

Expected variable level < breakeven value: Select variable with the higher

variable cost. (larger slope on the TC line

Expected level > breakeven value: Select alternative with lower variable cost

(smaller slope on the TC line.

Problem 8.2

Salvage $4000 0

1. Find variable annual cost: let x = represent number of tons per year

$2 4 1 hour x tons

a. Annual VC = hour 8 tons year = 3x

b. AW AW= -23000(A/P,10%,10) + 4000(A/F,10%,10) +-3500 -3x =

-6992 -3x

a. Annual VC = $12 hour

x 3oper x1hour x xtons

x 6tons x year = 6x

b. AW = -8000(A/P,10%,5) -1500-6x

-$3610 6x

Equate the two costs 6992 -3x = 6992 -3x x = 1127 tons

If the output is over 1127 ton select the auto. If less purchase the manual

Usually one factor at a time is varied and independence with other factors is assumed.

This assumption is not completely correct in real world situations, but it is a practical

way to evaluate variations, Sensitivity analysis how a measure of worth ie, PW,AW,

ROR or B/C and the and the alternative may be altered if a particular parameter varies

over a stated range of values. For example some variation in MARR will not likely alter

the decision.

2. Variation of more than one factor for a single project,

3. Sensitivity of selection from multiple mutually exclusive alternatives to variation of

more than one parameter.

1. Determine which parameter of interest might vary from the most likely estimated

value

2. Select the most probable range (numerical or percentage) and an increment of

variation for each parameter.

3. Select the measure of worth

4. Compute the results for each parameter using the measure of worth.

5. To better interpret the sensitivity graphically display the parameter versus the

measure of worth.

Problem 8.4 Is really self explanatory if you have trouble with this go to Ask the

Professor and let me know. Even the graphing and the explanation are easy

When sensitivity of several parameters is considered for one project using a single

measure of worth, it is helpful graph percentage change for for each parameter

using a single measure of worth. Problem 8.5 shows this technique.

The solution for these is really just more of the same. The easiest way is to set up

the table 8.1 There is really nothing new. Again if you have a problem just Ask the

Professor

I hope that you have enjoyed this course. I am sure that you will find what you

learned helpful in your career and in your personal life, I know that it did for me. I

know that at times there was some difficulty in understanding the problems, but I

think that you will find that it is worth it. As I said in the beginning this was a problem

solving course. You had many problems for the assignments, midterm, and final. I

am sure that if you are reading this you were successful in those attempts.

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