Operations Management
Break-Even Analysis - Lecture 4.2
Dr. Ursula G. Kraus
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Review
• Merton Truck
2/20
Agenda
• Acquiring Capacity: Break-Even Analysis
• Applied Decision Problems
4/20
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
5/20
Break-Even Analysis
Total Costs (TC) = FC + VC = FC + v * Q
Total Revenue (TR) = R * Q
where:
v = variable costs per unit
R = revenue per unit
Q = volume of output
6/20
Break-Even Chart
Cost/Revenue in Dollars
Total revenue line
Profit
Breakeven point
Total cost = Total revenue
Total cost line
Variable cost
Loss
Fixed cost
Volume (units/period)
7/20
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)
b)
c)
How many pies must be sold in order to break even?
What would the profit (loss) be if 1,000 pies are made and
sold a month?
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
Cost in Dollars (Thousands)
Process A: low volume, high variety
Process B: Repetitive
Process C: High volume, low variety
Fixed cost - Process C
Fixed cost - Process B
Fixed cost - Process A
Process A
Process B
Process C
Volume (units/period)
11/20
Example: Vending Machines
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?
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Cost/Revenue in Dollars (Thousands)
Break-Even Chart:
Vending Machines
Volume (units/period)
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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:
Cost of Materials:
$5.00/dozen
$2.50/dozen
Sale Price of Oatmeal Raisin Cookies:
Cost of Materials:
$5.50/dozen
$2.40/dozen
Maximum weekly demand of
Chocolate Chip Cookies:
Maximum weekly demand of
Oatmeal Raisin Cookies:
Total weekly operating expense
100 dozen
50 dozen
$270
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Product Mix Decisions
Total time available per week: 20 hrs
Processing
Times
Mix &
Spoon
Chocolate
Chip
8 mins.
(6+2/doz)
1
9
Oatmeal
Raisin
5 mins.
(3+2/doz)
1
14
Resource
You
RM+Oven
Oven
Load & Set Bake Cool
Timer
Pack
Payment
Total
5
2/ doz
1
26
2
2/ doz
1
25
RM
RM
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