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Engineering Economy

Ryan Jeffrey P. Curbano, CIE


BREAK EVEN ANALYSIS
Break even Analysis
Break even analysis
- is used to determine the break even cost,
which is the cost at which the total income
is exactly equal to the total expenses
incurred in the business.
Break-Even Chart
50,000

Revenue
40,000
Break-even
point Total
30,000
costs
Dollars

20,000

Fixed costs
10,000


| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Units
Break-Even Analysis
BEPx = break-even point in x = number of units produced
units
BEP$ = break-even point in TR = total revenue = Px
dollars F = fixed costs
P = price per unit (after all V = variable cost per unit
discounts) TC = total costs = F + Vx

Break-even point occurs


when

TR = TC F
or BEPx =
P-V
Px = F + Vx
Break-Even Analysis
BEPx = break-even point in x = number of units produced
units
BEP$ = break-even point in TR = total revenue = Px
dollars F = fixed costs
P = price per unit (after all V = variable cost per unit
discounts) TC = total costs = F + Vx

BEP$ = BEPx P
= F P Profit = TR - TC
P-V = Px - (F + Vx)
= F
= Px - F - Vx
(P - V)/P
F = (P - V)x - F
=
1 - V/P
Example 1.0
A manufacturer produces certain items at
a labor cost of P115 each, material cost
P76 each and variable cost of P2.32 each.
If the item has a unit price of P600. how
many number of units must be
manufactured each month for the
manufacturer to break even if the monthly
overhead is P428,000
Example 2.0
A company which manufactures electric
motors has a production capacity of 200
motors a month. The variable cost are
P150.00 per motor. The average selling
price of the motors is P275.00. Fixed cost
of the company amount to P20,000 per
month which includes taxes. Find the
number of motors that must be sold each
month to break even.
Example 3.0
A factory engaged in the fabrication of an
automobile part with a production capacity of
700,000 units per year is only operating at 62%
of capacity due to unavailability of the necessary
foreign currency to finance the importation of
their raw materials. The annual income is
P430,000.00. Annual fixed cost are P190,000.00
and variable cost are P0.348 per unit
What is the current profit or loss?
What is the break even point?
Example 4.0
The Asian Transmission Co. makes and
sell certain automotive parts. Present
sales volume is 500,000 units per year at
a selling price of P0.50 per unit. Fixed
expenses total P80,000 per year.
What is the present total profit for a year
What is the present break even point in pesos
and in units.
Example 5.0
The following data for year 2000 are available for
Cagayan Automotive Company which manufactures and
sell a single automotive product line.
Unit selling price P40.00
Unit variable cost P20.00
Unit contribution margin P20.00
Total Fixed Cost P200,000.00
What is the breakeven point in units for the current year?
DEPRECIATION
Depreciation
Depreciation
Is the reduction of fall in the value of an asset
or physical property during the course of its
working life and due to the passage of time
Types of Depreciation
Physical Depreciation
Is due to the reduction of the physical ability
of an equipment or asset to produce result.
Functional Depreciation
Is due to the reduction in the demand for the
function that the equipment or asset was
designed to render. This type of depreciation
is often called obsolescence.
Methods of Computing Depreciation

Straight line Method


In this method of computing depreciation, it is
assumed that the loss in value is directly
proportional to the age of the equipment or
asset.
Formula Straight line method

Annual depreciation charge, d


d = Co - Cn
n
Where:
Co = first cost
Cn = cost after n years (salvage/scrap value)
Book value at the end of m years of using, Cm
Cm = Co Dm
Where: Dm = total depreciation after m years
Dm = d(m)
Sinking Fund Method
In this method of computing depreciation, it is
assumed that sinking fund is established in
which funds will accumulate for replacement
purposes
Formula Sinking Fund
Annual depreciation charge, d
d = (Co Cn)i
n
(1 + i) 1
Where:
Co = first cost
Cn = cost after n years (SV)
n = life of the property

Book value at the end of m years of using , Cm


Cm = Co Dm
Where: Dm = total depreciation after m years
n
Dm = d[(1+i) - 1]
i
Declining Balance Method
In this method of computing depreciation, it
is assumed that the annual cost of
depreciation is fixed percentage of the book
value at the beginning of the year. This
method is sometimes known as constant
percentage method or the Matheson
Formula
Formula Double Balance Method
m
k = 1 n Cn Book Value = FC (1-k)

Co Depreciation at the end of


m years
k = 1 m Cm m -1
d = (FC)(1-k) k
Co
Note: the value of k is the constant percentage. Hence k
must be decimal and a value less than 1. In this method,
salvage or scrap value must not be zero.
Sum of Years Digit (SYD) Method
First year d1 = (Co Cn) n
years
- Second year d2 = (Co Cn) n-1
years

- Third year d3 = (Co Cn) n 2 and so on


years
Book value at the end of m years of using, Cm
Cm = Co (d1 + d2 ++dm)
Sum of years digit
years = n(n+1)
2
Double Declining Balance Method

In this method the depreciation during any


year is a constant ratio of the book value
at the beginning of the year.
Formula:
k = 2/n
m
Book value = (FC)(1-k)
m-1
Depreciation = (FC)(1-k) (k)
Service Output Method
In this method it is assumed that the total
depreciation that has taken place is
directly proportional to the quantity of the
output of the property up to the time.
Formula Service Output Method

Depreciation per unit output is


d1 = Co Cn
T
Depreciation charge during m year
Where:
Dm = Qmd1 T = total units of output produced
= (Co Cn)Qm M = age in years of the property at any
time
T Qm = total units of output during year m
Dm = depreciation charge during year m
Co = original cost of the property
Cn = book value at the end of life, n years
Working Hours or Machine Hour
Method
Formula

Depreciation per hour = FC SV


Total number of hrs
Example 1.0
In order to established the comparison between the
depreciation methods mentioned above, let us consider
the following data:
First cost (Co) = P10,000
Salvage value, Cn = P500
Life of property = 5 years
Solve using the Straight line method, Sinking Fund at 10%,
Matheson Formula and SYD method
Example 2.0
A certain company makes it the policy that
for any new piece of equipment that
annual depreciation cost should not
exceed 10% of the original cost at any
time with no salvage value or scrap value.
Determine the length of service life
necessary if the depreciation method used
is (a) the straight line formula (b) sinking
fund at 8% ( c) SYD method
Straight line Method
A machine has an initial cost of P50,000
and a salvage value of P10,000 after 10
years. What is the book value after 5 years
using straight line depreciation.
Straight line Method
An asset is purchased for P500,000. the
salvage value in 25 years is P100,000.
what is the total depreciation in the first
three years using SLM
Straight line Method
A manufacturing plant was built at a cost
of P5M and is estimated to have a life of
20 years with a salvage value of P1M. A
certain equipment worth P570,000 was
installed at a cost of P80,000 is expected
to operate economically for 15 years with
a salvage value of P50,000. Determine the
book value of the plant and equipment
after ten years, Use Straight line method
Straight line Method
The cost of the printing equipment is
P500,000 and cost of handling and
installation is P30,000. if the book value of
the equipment at the end of the 3rd year is
P242,000 and the life of the equipment is
assumed to be 5 years, determine the
salvage value of this equipment at the end
of 5 years
Sinking Fund Method
A plant erected to manufacture socks has
a first cost of P10,000,000 with an
estimated salvage value of P100,000 at
the end of 25 years. Find the appraised
value using sinking fund method assuming
an interest of 6% at the end of 10 years
and 20 years
Sum of Years Digit Method
A company purchases an asset for
P10,000 and plans to keep it for 20 years.
If the salvage value is zero at the end of
20th year. What is the depreciation in the
third year? Use SYD method
Sum of Years Digit Method
ABC Corporation makes its policy that for
every new equipment purchased, the
annual depreciation cost should not
exceed 20% of the first cost at any time
without salvage value. Determine the
length of service if the depreciation used is
the SYD method
Declining Balance Method
A machine cost P7350 has a life of 8 years
and has a salvage value of P350 at the
end of 8 years. Determine its book value
at the end of 4 years using Declining
balance method
Declining Balanced Method
The original cost of a certain machine is
P150,000 has a life of 8 years with a
salvage value of P9,000. how much is the
depreciation on the 5th year, using
declining balanced method
Declining Balanced Method
A machine costing P720,000 is estimated
to have a book value of P40,545.73 when
retired at the end of 10 years. Depreciation
cost is computed using a constant
percentage of the declining book value.
What is the annual rate of depreciation in
%?
Double Declining Balanced Method
Erectors Co. owns earth moving
equipment that cost P90,000. After 8 years
it will have estimated salvage value of
P18,000. compute the depreciation charge
using double declining balanced method
for 1st two years and book value at the of 5
years.
Working Hours Method
A lathe machine costs P300,000 (brand
new) with a salvage value of P15,000 is
expected to last for 28500 hours in a
period of 5 ears. In the first year of
service it was used for 8000 hrs.
compute the depreciation for the 1st year
and book value at the end of the first
year.
Service Output Method
A certain machine cost P40,000 and has a
life of 4 years and salvage value of
P5,000. the production output of this
machine in units per year for first year,
1800 units, second year 2200 units, third
year 3,000 units, fourth year 4,000 units. If
the units produced are of uniform quality,
what are the annual depreciation charges?