Matakuliah
Tahun
: D0762 – Ekonomi Teknik
: 2009
Break Even Point and Payback Period
Course Outline 11
Outline
• Break Even AnalysisNext
• Payback Period Next
• Case Study Next
References :
- Engineering Economy – Leland T. Blank, Anthoy J.
Tarquin p.486-506
- Engineering Economic Analysis, Donald G. Newman, p.
238-245
- Engineering Economy, William G. Sulivan, p.21-35, p.
240-243
2
Break Even Analysis
• Determine the quantity of a variable at which revenues and costs
are equal in order to estimate the amount of profit or loss
• The quantity called the breakeven point
3
Type of Cost considered for Break Even Analysis
Fixed Costs (FC) :
include cost such as buildings, insurance, fixed overhead or indirect
costs, some minimum level of labor, and capital recovery
usually constant for all values of the variable.
Variable Cost (VC) :
Include costs such as direct labor, materials, indirect and support
labor, contractors, marketing, advertisement, and warranty
Change with production level, workforce size, and other variables.
4
Costs/Revenue
Break-Even Analysis
TR
TR
TC
VC
The Break-even
The revenue
lower theisprice,
Total
As output
iswhere
point
occurs
The
total
costs
theInitially
less
steep
the
a
firm
determined
by
the
generated,
the
total
revenue
therefore
total
revenue
curve.
will
incur
fixed
price
charged
and
firm
will
incur
equals
total costs –
(assuming
the
quantity
sold –
costs,
these
variable
costs
–
the
firm,
in
this
accurate
again
this
will
be
do
not
depend
these vary
example
would
determined
byisor
forecasts!)
the
on
output
directly
with
the
have
to
sell
Q1
expected
forecast to
sum
of FC+VC
sales.
amount
sales
initially.
generate
sufficient
produced
revenue
to cover its
costs.
FC
Q1
Output/Sales
Http://bized.ac.uk
Costs/Revenue
Break-Even Analysis
TR (p = £3)
TR (p = £2)
TC
VC
If the firm chose
to set price
higher than £2
(say £3) the TR
curve would be
steeper – they
would not have
to sell as many
units to break
even
FC
Q2
Q1
Output/Sales
Http://bized.ac.uk
Break-Even Analysis
TR (p = £1)
Costs/Revenue
TR (p = £2)
TC
VC
If the firm chose
to set prices
lower (say £1) it
would need to
sell more units
before covering
its costs
FC
Q1
Q3
Output/Sales
Http://bized.ac.uk
Break-Even Analysis
TR (p = £2)
Costs/Revenue
Profit
TC
VC
Loss
FC
Q1
Output/Sales
Http://bized.ac.uk
Break-Even Analysis
Costs/Revenue
TR (p = £3)
TR (p = £2)
TC
VC
Margin of
A
higher
safety
shows
how farwould
sales
price
can fall the
before
lower
Assume
losses made. If
break
even
current
Q1
= 1000 and
point
and
Q2
= 1800,
sales
at Q2
salesmargin
could fall
the
by safety
800 units
of
before a loss
would
widen
would be made
Margin of Safety
FC
Q3
Q1
Q2
Output/Sales
Http://bized.ac.uk
Costs/Revenue
Eurotunnel’s
High initial
FC 1 FC.
problem
Interest on debt
rises each year –
FC rise therefore
FC
Losses get
bigger!
TR
VC
Output/Sales
Break-Even Analysis
• Remember:
A higher price or lower price does not mean that break
even will never be reached!
The BE point depends on the number of sales needed to
generate revenue to cover costs – the BE chart is NOT
time related!
Http://bized.ac.uk
Break-Even Analysis
• Importance of Price Elasticity of Demand:
• Higher prices might mean fewer sales to break-even
but those sales may take a longer time to achieve.
• Lower prices might encourage more customers but
higher volume needed before sufficient revenue
generated to break-even
Http://bized.ac.uk
Break-Even Analysis
Links of BE to pricing strategies and elasticity
• Penetration pricing – ‘high’ volume, ‘low’ price – more
sales to break even
• Market Skimming – ‘high’ price ‘low’ volumes – fewer
sales to break even
• Elasticity – what is likely to happen to sales when prices
are increased or decreased?
Http://bized.ac.uk
Payback Period
• Payback Period, often called the simply payout method
• Mainly indicates a project’s liquidity rather its profitability.
• Calculates the number of years required for cash inflows
to just equal outflows.
• Define as the period of time required for the profit or
other benefits of an investment to equal cost of the
investment
14
Basic Concepts
• Answer :
the period of time required for the profit or other benefits of an
investment to equal cost of the investment
• Method:
Based on cumulative cash flow (accounting profit)
• Weakness:
Ignores the time value of money
Payback period is used because
1. the concept can be readily understood,
2. the calculations can be readily made and understood by people unfamiliar
with the use of the time value of money.
It’s “better than nothing.” Use it as a last resort to communicate.
15
Payback Period: Example
Year
-$30,000
-$35,000
1
12,000
1,000
2
9,000
4,000
3
6,000
7,000
4
3,000
10,000
Benefits
5
0
13,000
Costs
6
0
16,000
7
0
19,000
8
0
22,000
Totals
0
57,000
Dura PBP Analysis
$100,000
$40,000
$20,000
$0
$50,000
Benefits
0 1 2 3 4 5 6 7 8
Costs
$0
012345678
Year
Dura
machine
0
A firm is buying production equipment for a new plant.
Two alternative machines are being considered.
Tempo PBP Analysis
Tempo
machine
Year
IRR
Tempo
0.00%
Dura
18.99%
PBP analysis would choose Tempo (PBP = 4 yrs.) instead of Dura (PBP = 5 yrs.).
However, with IRR analysis we can see that Tempo is not a very attractive investment
Although, Tempo does return its investment more quickly than Dura.
16
Payback Period: Summary
Lesson from Example: liquidity and profitability can be very different criteria.
Final Conclusions about PBP Analysis
This analysis provides a measure of the speed of the return of the investment.
If a company is short of working capital, or experiences a rapidly changing technology,
the speed of return can be important.
PBP analysis should not be confused with careful economic analysis.
PBP analysis does not always mean the investment is economically desirable.
1.
Payback period is an approximate, rather than an exact, analysis calculation.
2.
All costs and all profits, or savings of the investment prior to payback, are included without considering
differences in their timing.
3.
All the economic consequences beyond the payback period are completely ignored.
4.
Payback period may or may not select the same alternative as an exact economic analysis method.
5.
Payback period is used because the concept can be readily understood, the calculations can be readily
made and understood by people unfamiliar with the use of the time value of money.
6.
PBP analysis is “better than nothing.” Use it as a last resort to communicate.
17