Engineering Economics (ME 703)

Chapter 2 : (2082/02/12) 3rd Class

COST CONCEPTS AND BEHAVIOR
Course Outline: Chapter 2
2.5 Cost-volume analysis
2.5 Understanding Cost-Volume-Profit (CVP) Analysis
2.5 Understanding Cost-Volume-Profit (CVP) Analysis

The cost-volume-profit analysis, also commonly known as

breakeven analysis, looks to determine the breakeven point
for different sales volumes and cost structures plotted on a
profit-volume chart, which can be useful for managers
making short-term business decisions. CVP analysis makes
several assumptions, including that the sales price, fixed and
variable costs per unit are constant. Running a CVP analysis
involves using several equations for price, cost, and other
variables, which it then plots out on an economic graph.
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Break Even Analysis
Sales Total Revenue

Angle of Incidence Total Cost

Margin of Safety

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 BE Analysis with Example

Product X Sales Table: SP=Rs.4, VC = Rs. 1.5 & FC=6,000

Items (Units) 0 1000 2000 3000 4000
Output
TR= (SP*Q) 0 4000 8000 12000 16000
TVC= (VC*Q) 0 1500 3000 4500 6000
TFC 6000 6000 6000 6000 6000
TC=TVC+TFC 6000 7500 9000 10500 12000
Profit/Loss (6000) (3500) (1000) 1500 4000

BEP=F.C./(S.P.-V.C.)=6000/(4-1.5)=2400 Units
BEP at Sales= 2400x4=Rs. 9,600

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The break-even analysis is based on the following set of
assumptions:
i. The total costs may be classified into fixed and variable
costs.
ii. The cost and revenue functions remain linear.
iii. The price of the product is assumed to be constant.
iv. The volume of sales and volume of production are equal.
v. The fixed costs remain constant over the volume under
consideration.
vi. It assumes constant rate of increase in variable cost.
vii. It assumes constant technology i.e. the efficiency of men &
machines remain constant.
viii. In the case of multi-product firm, the product mix is stable

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BEA Formula
1) Break Even Point Q = F.C./(S-V), No profit/loss
(S-V)= Contribution Per Unit
Total Revenue (TR)= Total Cost (TC)
= TFC + TVC at BEP (No Profit/Loss)
2) TR-VC= FC+ Profit (Desired Profit by Mgnt.)
QxS-QxV=FC+ Profit
Q(S-V)=FC + Profit
Q=(FC+Profit)/(S-V)
3) Profit Volume Ratio = Contribution*100/Sales
P/V= ((S-V)x100%)/Sales (Prefer for higher P/V)
4)Margin of safety=(Sales-Sales at BEP)*100/Sales
Margin of safety is the distance between the BEP and the output
being produced.
5) Contribution Margin Ratio = Contribution Margin Per unit/S.P.
BEP (Sales in Rs.)= TFC/ Contribution Margin Ratio
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Nu.3) Find BEP both in units and values. What
would be the effect on profit/loss when FC
increases by 20% & selling price decreases by
30%
F.C. = Rs. 30 Million
V.C.=Rs. 25,000 Per unit
S.P.= Rs. 50,000 Per unit

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Solution:
i)BEP=F.C./(S.P.-V.C.)=30000000/(50000-25000)
=1200 Units
Breakeven Cost=1200x50000=Rs. 60000000
ii) New fixed cost = 20% of 30 Million= 36 Million
Selling price less 30%=50000-50000x30%=35,000
Sales (Total Revenue)-V.C.-F.C.= Profit/Loss
1200x35000-1200x25000-36000000=Profit/Loss
=-24000000
There would be loss when FC increases by 20% &
selling price decrease by 30%

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Home Assignment: Chapter 2
1. What do you understand by BEP? Describe the BEP with
suitable examples. What are the assumption made in Breakeven
analysis?
2. Describe the various elements of cost and explain how selling
price of the product is determined?
3. What do you understand by product cost and period cost in
financial statement? Explain the with proper flow diagram.
4. Explain the following terms with proper diagram: Average
Fixed Unit cost, Average Variable Unit cost, Average Total Unit
Cost and marginal Cost.
5. Write short notes on
a) Opportunity Cost b) Marginal Cost c) Sunk Cost d)
Differential Cost
6. All related numerical
Q4. An executive from a large merchandising firm has
called your vice-president for production to get a price
quote for an additional 100 units of a given product. The
vice-president has asked you to prepare a cost estimate.
The number of hours required to produce a unit is 5. The
average labor rate is Rs.12 per hour. The materials cost
Rs.14 per unit. Overhead for an additional 100 units is
estimated at 50% of the direct labor cost. If the company
wants to have a 30% profit margin, what should be the
unit price to quote?

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Solution: Additional units ordered = 100
Labor cost = 12x5x100 = Rs.6,000
Material cost = 14x100 = Rs.1,400
Overhead cost = (50%) x(6,000) = Rs.3,000
Total cost = 6,000 + 1,400 +3,000 = Rs.10,400
Profit margin = (30%) (10,400) = Rs.3,120
∴ Unit price to quote = 10,400 + 3,120 =13520
= 13,520 /100=Rs.135.20
Nu. Q5. A concern is manufacturing a product which is sold for
Rs. 10.50 per unit and the fixed cost of the asset is Rs. 50,000 and
sets a variable cost of Rs. 6.50 per unit. How many units should
be produced to break even? How many units should be produced
to earn a profit of Rs. 10000? What would be the profit for sales
value of 20000 units?
Solution: F.C. =50,000, VC=6.5, SP=10.50 Desired profit =10000
i)BEP (Q)=F.C./(S.P-V.C.)=50000/(10.50-6.50)=12,500 Units
ii) Q(S-V)= F.C.+ profit
Q(10.50-6.50)=50000+10000
Q=15000 Units
iii) Profit for 20000 Units?
Q(S-V)=FC + Profit
Profit= Q(S-V)-FC
= 20000(10.50-6.50)-50000= Rs. 30,000

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Nu. Q.No. 6
Find BEP in units and BEP in sales if
Selling price =90 per unit
Variable Cost(Marketing)=8 per unit
Variable Cost (Mfg.) =50 per unit
Fixed Cost =96,000
Solution:
Sales- VC- FC= Profit(=0 at BEP)
90Q-58Q-96000=0
Q= 3000 Unit
BEP in units=3000 Units
BEP in sales = 3000x90=Rs. 270,000
Nu. Q7. The Morton Company produces and sells two products: A and
B. Financial data related to producing these two products are
summarized as follows:
Des. Product A Product B

S.P. Rs. 10 Rs. 12

V.C. Rs. 5 Rs. 10

Fixed Cost Rs. 600 Rs. 2000

(a) If these products are sold in the ratio of 4A for 3B, what is the break-even
point?
(b) If the product mix has changed to 5A for 5B, what would happen to the
breakeven point?
(c) In order to maximize the profit, which product mix should be pushed?
(d) If both products must go through the same manufacturing machine and
there are only 30,000 machine hours available per period, which product
should be pushed? Assume that product A requires 0.5 hour per unit and B
requires 0.25 hour per unit.

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Solution:
(a) If the products are sold in a ratio of 4A:3B, what is
the break-even point?
Let’s calculate the weighted average contribution margin
(WACM):
Assume 7 units are sold in total:
4 units of A → 4 × Rs. 5 (Contribution Margin) = Rs. 20
3 units of B → 3 × Rs. 2 = Rs. 6
Total contribution margin = Rs. 26
So, WACM per unit = Rs. 26 / 7 ≈ Rs. 3.71
Now, total fixed costs = Rs. 600 (A) + Rs. 2000 (B) = Rs.
2600
Break-even units = Total Fixed Cost / WACM
= Rs. 2600 / 3.71 ≈ 701 units (rounded up)
Now split this based on 4:3 ratio:
A = 4/7 × 701 ≈ 401 units
B = 3/7 × 701 ≈ 300 units
Solution
(b) 10A + 12A = 5A + 10A + 2,600; A = B=371.43 units
(c) Compute the marginal contribution rate (MCR) for each
product: Product A = Rs. 5, Product B= Rs. 2; with the
assumption (A > 0 and B > 0), more preference should be
given to product A
(d) Product A: MCR = Rs. 5 per unit; Production time = 0.5
hour per unit; profit per hour = Rs.10
Product B: MCR = Rs. 2 per unit; Production time = 0.25
hour per unit; profit per hour = Rs. 8
Conclusion: Product A is more profitable, so it should be
pushed first.
Nu. Q8. Bragg & Stratton Company manufactures a specialized
motor for chain saws. The company expects to manufacture and
sell 30,000 motors in year 2024. It can manufacture an additional
10,000 motors without adding new machinery and equipment.
Bragg & Stratton’s projected total costs for the 30,000 units are as
follows:
Direct Materials NRs. 150,000 Manufacturing overhead:
Direct labor NRs. 300,000 Variable portion NRs. 100,000
Selling and administrative costs: Fixed portion NRs. 80,000
Variable portion NRs. 180,000
Fixed portion NRs. 70,000

The selling price for the motor is NRs. 80. (a) What is the total
manufacturing cost per unit if 30,000 motors are produced? (b)
What is the total manufacturing cost per unit if 40,000 motors
are produced? (c) What is the break-even price on the motors?
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Solution:
(a) Total unit manufacturing costs if 30,000 units are
produced:
Total mfg. costs=150,000+ 300,000 +180,000= 630,000
Unit cost =630,000 / 30,000= Rs. 21
(b) Total unit manufacturing costs if 40,000 units are
produced:
Total mfg. costs =
(5*40000+10*40000+40000*(100000/30000)+80000
(DM+DL+Mfg. overhead + Mfg. Overhead fixed portion)
=200,000+400,000+133,333+80,000=813,333
Unit cost =813,333/40,000=Rs.20.21
(c) Break-even price with 30,000 units produced:
Total cost =Mfg. cost + Selling & Admin.
=630,000+250,000=880,000
Unit cost =880,000/30,000=Rs.29.33
Nu. Q.9 The data of an industrial units is as follow:
Fixed costs of assets=Rs. 24000, Sales price/unit=Rs. 10
Contribution for 8000 units = Rs. 16000
i)What is the sales volume for breakeven?
ii) What should be selling price if the breakeven quantity is to be brought down
to 10000 Units?
Given: FC=24000
Selling prices/Unit=Rs. 10
V= Variable cost perunit
Contribution per piece or unit =16000/8000=Rs. 2 Per unit
Now contribution= S-V=2
Or, 10-V=2
Variable cost per unit = Rs. 8
i)BEP= FC/(S.P-V.C.)=24000/(10-8)=12,000 Units
ii) Also BEP = 10000 Contribution per unit will be
Contribution Per Unit (S-V)= FC/Q=24000/10000=Rs. 2.40
So the sales price perunit = V+ Contribution/Unit
S=V+C=8+2.40= Rs. 10.40
Hence the selling price of BEP of 10000 units should be Rs. 10.40 perunit