Ch 5(B) : Capacity Planning: Break-Even

Analysis Operation costs are divided into 2 main groups:

• Fixed costs

• Variable costs

1

Include rent, property tax, property insurance, wages of permanent employees, depreciation (except in working hour depreciation).

The total fixed cost is fixed throughout the year.

It does not depend on the production level.

When we have a plant, then the above costs are fixed, no matter if we produce one unit or one million units.

Fixed Costs

2

Total Fixed Cost and Fixed Cost per Unit of Product

Total fixed cost (F)

Production volume (Q)

Fixed cost per unit of product

(F/Q)

Production volume (Q)

3

Variable Costs

Costs of raw material, packaging material, direct labor, production W&P are the main variable costs.

Variable cost is fixed per unit of production. The total variable costs depend on the volume of production.

The higher the production level, the higher the total variable costs.

4

Variable Cost per Unit and Total Variable Costs

Total Variable costs(VQ)

Variable costsPer unit of product(V)

Production volume (Q) Production volume (Q)

5

Am

ou

nt

($)

0Q (volume in units)

Total variable cost (V

Q)

Total Fixed cost (F)

Total Costs

Total cost = F+VQ

6

Total Revenue

It is assumed that the price of the product is fixed, and we sell whatever we produce. Total sales revenue depends on the production level. The higher the production, the higher the total sales revenue.

Total revenue (TR)

Production (and sales ) (Q)

Price per unit (P)

Production (and sales) (Q) 7

Am

ou

nt

($)

Q (volume in units)0 BEP units

Profit

Total r

even

ue

Total cost

Break-Even Point

Loss

8

TC=TR

Break-Even Computations

TR=PQ

TC=F+VQ

QBEP = F/ (P-V)

F+VQ=PQ

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Example

$500,000 total yearly fixed costs.$150 per unit variable costs$200 per unit sale price

QBEP=500,000/(200-150) =10,000 units

If our market research indicates that the present demand is > 10,000, then this manufacturing system is economically feasible.

10

BEA for Multiple Alternatives

Break-even analysis for multiple alternatives:Such an analysis is implemented to compare cases such as

In general, when we move from a simple technology to an advanced technology; F V

A Simple technology An Intermediate technology An Advanced technology

General purpose machines Multi-purpose machines Special purpose machines

Low F high V In between High F Low V

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BEA for Multiple Alternatives

Universal

CNCs

CIM

Q1 Q212

I can buy

1) A General Purpose machineTotal Fixed Cost F = $10,000, Variable cost V = $10 per unit

2) A Multi Purpose machineTotal Fixed Cost F = $60,000, Variable cost V = $5 per unit

3) A Single Purpose machineTotal Fixed Cost F = $150,000, Variable cost V = $2 per unit

BEA for Multiple Alternatives

Tell me what to do: In terms of the range of demand and the preferred choice…

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BEA for Alternatives (1) and (2)

1

2

Q114

F1=10000 V1=10F2=60000 V2=5

Q = 10000510

1000060000

Break-Even for Alternatives (1) and (2)

Break-even of 1 and 2

F1+ V1 Q = F2+ V2 Q

10000+10Q = 60000 + 5Q

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BEA for Alternatives (2) and (3)

2

3

Q216

F2=60000 V2=5F3=150000 V3=2

Q = 3000025

60000150000

Break-Even for Alternatives (2) and (3)

Break-even of 2 and 3

F2+ V2 Q = F3+ V3 Q

60000 + 5Q = 150000+2Q

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Demand Recommended Alternative

D < 10000 Alternative 1

10000 < D < 30000 Alternative 2

30000 < D Alternative 3

We also need to know Price and Revenue!

Recommendations to Management and Marketing

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Assignment 3: Problem 1

A firm plans to begin production of a new small appliance.

Management should decide whether to make the small enginefor this product in-plant, or buy it from an outside source. If management decides to make the engine, then there are 2 alternatives:

(1) Built it with a simple manufacturing systemFixed Cost: $10,000/yearVariable Cost: $8 per unit

(2) Built it with an advanced manufacturing system.Fixed Cost: $30,000/yearVariable Cost: $5 per unit

The purchase price of the engine is $10 per unit.

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Prepare a table similar to the following table, to summarize your recommendations.

Demand Recommendation

Q <= ? ?

? < Q < = ? ?

? < Q ?

BEP for the Three Alternatives and Recommendations

20

A manager has the option of purchasing 1, 2 or 3 machines.The capacity of each machine is 300 units.

Fixed costs are as follows:

Number of Machines Fixed cost Total Capacity 1 $9,600 1-300 2 $15,000 301-600 3 $20,000 601-900

Variable cost is $10 per unit, and the sales price of product is $40 per unit.

Tell management what to do!

Assignment 3: Problem 2

21

BEP for the Three Alternatives and Recommendations

Prepare an executive summary similar the following:

Q<= ? ??<Q<=? ?Q>? ?

Now it is up to the Marketing Department to provide an Executive Summary regarding the demand.

22

You are the production manager and are given the option to purchase either 1, 2 or 3 machines. Each machine has a capacity of 500 units. Fixed costs are as follows:

Number of Machines Fixed cost Total Capacity 1 $19,200 1- 500 2 $30,000 501-1000 3 $40,000 1001-1500

Variable cost is $35 per unit, and the sales price of product is $69 per unit.

Determine the best option!

Assignment 3: Problem 3

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BEP for the Three Alternatives and Recommendations

Prepare an executive summary similar the following:

Q<= ? ??<Q<=? ?Q>? ?

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