ENGINEERING

ECONOMY

COURSE CODE: BES211

LEC: 3 Units
BREAK-EVEN
ANALYSIS
LOSS PROFIT
BREAK-EVEN ANALYSIS
In ENGINEERING ECONOMY, many situations are encountered where the cost of
two or more alternatives may be affected by a common variable. BREAK-EVEN POINT is
the value of the variable for which the costs for the alternatives will be equal

𝐂𝟏 = 𝐟𝟏 (𝐱) 𝐚𝐧𝐝 𝐂𝟐 = 𝐟𝟐 (𝐱)

where:
𝐂𝟏 = certain specified total cost applicable to Alternative 1
𝐂𝟐 = certain specified total cost applicable to Alternative 2
𝐱 = a common independent variable affecting Alternative 1 and Alternative 2

The break-even point is where 𝐂𝟏 and 𝐂𝟐 are equal,

𝐂𝟏 = 𝐂𝟐
𝐟𝟏 𝐱 = 𝐟𝟐 (𝐱)
which may be solved for x, the break-even point.
BREAK-EVEN CHART
BREAK-EVEN CHART is a graphical representation of break-even analysis.

The BREAK-EVEN POINT is the quantity of production at which the income is equal to
total cost. It is the intersection of the income line and the total cost line on the break-
even chart.
When two alternatives are to be compared, the break-even point is the intersection of the
total cost line for each alternative on the break-even chart.
Example Problem:
Two machines are being considered for the production of a particular part for which there is a long-term demand.
Machine A costs P50,000 and is expected to last 3 years and have a P10,000 salvage value. Machine B costs P75,000 and
is expected to last 6 years and have zero salvage value. Machine A can produce a part in 18 seconds; Machine B requires
only 12 seconds per part. The out-of- pocket hourly cost of operation is P38 for A and P30 for B. Monthly maintenance costs
are P200 for A and P220 for B.
If interest on invested capital is 25%, determine the number of parts per year at which the machines are equally
economical. If the expected number of parts per year is greater than this break-even quantity, which machine would be
favored?
Solution: ALGEBRAIC SOLUTION
Let 𝐍 = number of parts per year for equal costs
By the annual cost method
Machine A
Annual costs: P50,000−P10,000 P50,000−P10,000
Depreciation = =
1 + 0.25 3 − 1
= P10,491.8034
F/A,25%,3
0.25
Maintenance = (P200) (12) = P2,400.00
18
Operation = (P38) ( ) (N) = 0.19𝐍
3,600

Interest on capital = (P50,000) (0.25) = P12,500.00

Total annual cost = P25,391.8034+ P0.19N

Continuation:
Machine B
Annual costs: P75,000 P75,000
Depreciation = =
1 + 0.25 6 − 1
= P6,661.4624
F/A,25%,6
0.25
Maintenance = (P220) (12) = P2,640.00
12
Operation = (P30) ( ) (N) = 0.10𝐍
3,600

Interest on capital = (P75,000) (0.25) = P18,750.00

Total annual cost = P28,051.4624+ P0.10N

Equating total annual cost,

P25,391.8034+ P0.19N = P28,051.4624+ P0.10N
N = 29,551.7667

Machine B will be more economical for number of parts more than 29,551.7667
Continuation:
By the rate of return on additional investment method
Machine A
Annual costs: P50,000−P10,000 P50,000−P10,000
Depreciation = =
1 + 0.25 3 − 1
= P10,491.8034
F/A,25%,3
0.25
Maintenance = (P200) (12) = P2,400.00
18
Operation = (P38) ( ) (N) = 0.19𝐍
3,600
Total annual cost = P12,891.8034+ P0.19N
Machine B
Annual costs: P75,000 P75,000
Depreciation = =
1 + 0.25 6 − 1
= P6,661.4624
F/A,25%,6
0.25
Maintenance = (P220) (12) = P2,640.00
12
Operation = (P30) ( ) (N) = 0.10𝐍
3,600
Total annual cost = P9,301.4624+ P0.10N
Annual savings on Machine B = (P12,891.8034 + P0.19N) − (P9,301.4624 + P0.10N) = P3,590.341 + P0.09N
Additional investment on Machine B = P75,000 − P50,000 = P25,000
P3,590.341+P0.09N
Rate of return on additional investment (25%) = = 0.25 ; N = 29,551.7667
P25,000
Machine B will be more economical for number of parts more than 29,551.7667
GRAPHICAL SOLUTION
Machine A Machine B
Fixed costs = P25,391.8034 Fixed costs =P28,051.4624
Variable costs = P0.19N Variable costs = P0.10N
When N = 50,000 parts When N = 50,000 parts
Variable costs =(P0.19) (50,000) = P9,500 Variable costs =(P0.10) (50,000) = P5,000
Total cost = P25,391.8034 + P9,500 Total cost = P28,051.4624+ P5,000
= 𝐏𝟑𝟒, 𝟖𝟗𝟏. 𝟖𝟎𝟑𝟒 = 𝐏𝟑𝟑, 𝟎𝟓𝟏. 𝟒𝟔𝟐𝟒
BREAK-EVEN CHART
40

𝐏𝟑𝟒, 𝟖𝟗𝟏. 𝟖𝟎𝟑𝟒

BE
𝐏𝟑𝟑, 𝟎𝟓𝟏. 𝟒𝟔𝟐𝟒
30 Fixed costs (Machine B)
Cost x P10,000
P28,051.4624
Fixed costs (Machine A)
P25,391.8034

20

10

0
10 20 30 40 50
No. of parts x 1000
Break-even point 29,500 parts (approximately)
Example Problem:
Two electric motors are being considered to power an industrial hoist. Each is capable of providing 100 hp.
Pertinent data for each motor are as follows:
Motor A Motor B Money is worth 20%. If the expected usage of the
hoist is 700 hours per year, what would the cost of electrical
Investment P25,000 P32,000 power have to be before Motor A is favored over Motor B?
Electrical efficiency 84% 88%
Note that:
Maintenance per year 400 600 𝐎𝐮𝐭𝐩𝐮𝐭 𝐏𝐨𝐰𝐞𝐫
𝐄𝐟𝐟𝐢𝐞𝐜𝐢𝐞𝐧𝐜𝐲 = 1 hp = 0.746 kw
Life, years 10 10 𝐈𝐧𝐩𝐮𝐭 𝐏𝐨𝐰𝐞𝐫

Solution: Let x = cost of electrical power for both motors to be equally economical
Motor A Motor B
Annual costs: Annual costs:
P25,000 P25,000 P32,000 P32,000
Depreciation = = = P963.07 Depreciation = = = P1,232.73
F/A,20%,10 1 + 0.20 10 − 1 F/A,20%,10 1 + 0.20 10 − 1
0.20 0.20
(100)(0.746)(700)(x) =P62,166.67 x (100)(0.746)(700)(x) =P59,340.91 x
Power = Power =
0.84 0.88

Maintenance = P400 Maintenance = P600

Interest on capital = P25,000 (0.20) = P5,000 Interest on capital = P32,000 (0.20) = P6,400
Total annual cost = P6,363.07 + 62,166.67 x Total annual cost = P8,232.73 + P59,340.91 x
Continuation:
P6,363.07 + 62,166.67 x = P8,232.73 + P59,340.91 x
x= P0.6616 per kwh
Motor A will be more economical for electrical power cost less than P0.6616 per kwh

BREAK-EVEN CHART FOR BUSINESS ENTERPRISE

I
Line C'C represents the fixed costs of
Costs and Revenue

production. Area C'COO'C is the fixed costs region.

profit V
Line C'V shows the variation in total variable
cost with production. C'V actually represent the sum
Break-even point of all production costs since its starting point is at C'.
B Area C'VCC' is the variable costs region and area
Variable costs C'VOO'C' is the total cost region.
loss
C’ C Line O'I represents the gross income from
sales. Area O’IOO' is the income region. Area BIVB is
Fixed costs the profit region and area BO'C'B is the loss region.

O’ O
Units of output or percent production
Example Problem:
The cost of producing a small transistor radio set consists of P23.00 for labor and P37.00 for materials. The fixed
charges in operating the plant are P100,000 per month. The variable cost is P1.00 per set. The radio set can be sold for P75.00
each. Determine how many sets must be produced per month to break-even.
Solution:

ALGEBRAIC SOLUTION GRAPHICAL SOLUTION

Let x = number of sets to be produced 8
per month to break-even 7.5
7.1
Total income = P75(x)

Coats and Income - P100,000

Total cost = P100,000+ (P23+ P37+ P1) x 6
= P100,000+ P61x
BE
To break-even,
Total income = Total Cost 4
P75x= P100,000+ P61x
x = 7,143 sets
2
Fixed costs

0
2,500 5,000 7,500 10,000
Number of Sets

Break-even point = 7,140 sets