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Operations Management

Break-Even Analysis - Lecture 4.2

Dr. Ursula G. Kraus

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Review

• Merton Truck

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• Acquiring Capacity: Break-Even Analysis• Applied Decision Problems

Agenda

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Acquiring Capacity: Break-Even Analysis

Break-Even Analysis estimates the income/cost tradeoffs of an organization under different operating conditions. It determines necessary levels of service or production to avoid loss.

Fixed Costs (FC) remain constant regardless of volume of output e.g. rental costs, property taxes, equipment cost, heating expenses, certain administrative costs

Variable Costs (VC) vary directly with the volume of output (Q) e.g. labor, materials, portion of utilities

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Break-Even Analysis

Total Costs (TC) = FC + VC = FC + v * Q

Total Revenue (TR) = R * Q

where:v = variable costs per unitR = revenue per unitQ = volume of output

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Break-Even Chart

Fixed cost

Variable cost

Total cost line

Total revenue line

ProfitBreakeven pointTotal cost = Total revenue

Volume (units/period)

Cos

t/R

even

ue

in D

olla

rs

Loss

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Example: Old-Fashioned Berry Pies

The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2.00 per pie, and pies would retail for $7.00 each.

a) How many pies must be sold in order to break even?

b) What would the profit (loss) be if 1,000 pies are made and sold a month?

c) How many pies must be sold to realize a profit of $ 4,000?

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Practice Example - Widgets

Company ABC sell widgets for $30 a unit. Their fixed cost for equipment is $100,000. Their variable cost is $10 per unit.

What is their break-even point?

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Acquiring Capacity: Process Alternatives

Fixed cost - Process A

Fixed cost - Process B

Fixed cost - Process CTotal cost - Process C

Total cost - Process B

Total

cost

- Pro

cess

A

Process A: low volume, high variety

Process B: RepetitiveProcess C: High volume, low variety

Process CProcess BProcess AVolume (units/period)

Cos

t in

Dol

lars

(T

hou

san

ds)

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The manager of a plant must decide whether to make or buy a certain item used in the production of vending machines.

It costs $200 per unit to buy the part. Alternatively the company could produce the part in-house. This can either be done by buying a semi-automatic lathe for $80,000 or buying a machine center for $200,000. With the lathe the cost of producing one unit is $75 where with the machine center one unit can be produced for just $15.

Which type of equipment should be purchased or should the parts production be outsourced?

Example: Vending Machines

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Break-Even Chart: Vending Machines

Volume (units/period)

Cos

t/R

even

ue

in D

olla

rs (

Th

ousa

nd

s)

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Break-Even Chart: Vending Machines

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Practice Example – Company XYZ

Company XYZ has to choose between two machines to purchase. They both make the same product which sells for $10 per unit.

Machine A has annual costs of $3000 and per unit cost of $5. Machine B has annual costs of $8000 and per unit cost of $2.

Which machine should be purchased?

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Practice Example – Company DEF

Company DEF has a choice of two machines to purchase: They both make the same product which sells for $10.

Machine A has fixed costs of $5,000 and a per unit cost of $5. Machine B has fixed costs of $15,000 and per unit cost of $1.

Under what conditions would you select Machine A?

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Kristen's Cookies

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Product Mix Decisions:Kristen Cookies offers 2 products

Sale Price of Chocolate Chip Cookies: $5.00/dozen

Cost of Materials: $2.50/dozen

Sale Price of Oatmeal Raisin Cookies: $5.50/dozen

Cost of Materials: $2.40/dozen

Maximum weekly demand of

Chocolate Chip Cookies: 100 dozen

Maximum weekly demand of

Oatmeal Raisin Cookies: 50 dozen

Total weekly operating expense $270

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Product Mix Decisions

Processing Times

Mix & Spoon

Load & Set Timer

Bake Cool Pack Payment Total

Chocolate Chip

8 mins. (6+2/doz)

1 9 5 2/ doz 1 26

Oatmeal Raisin

5 mins. (3+2/doz)

1 14 2 2/ doz 1 25

Resource You RM+Oven Oven RM RM

Total time available per week: 20 hrs