Breakeven Analysis in Decision Making

Breakeven Analysis

• Breakeven analysis determines the value of a variable that makes two elements equal, such as the sales volume that equates revenues and costs.
• It is used to determine when two alternatives are equally acceptable.

Applications of Breakeven Analysis

• Commonly applied in make-or-buy decisions to determine the source for manufactured components, services, etc.

Payback Analysis

• Determines the required minimum life of an asset, process, or system to recover the initial investment.
• There are two types of payback: return (i.e., 0%) and no return (I=0%).

Limitations of Payback Analysis

• Not a final decision maker, but rather a screening tool or supplemental information for other analyses (e.g., PW, AW).
• Estimates are considered certain; if variable values may change the outcome, another study is necessary.

Advanced Analysis Techniques

• Sensitivity analysis is used when the variable of interest is allowed to vary.
• Simulation can be used to supplement breakeven or payback studies, considering probability and risk assessment.

Breakeven Analysis

• Breakeven quantity can be determined by setting an equivalence relation for PW or AW equal to zero when one of the engineering economy symbols (P, F, A, i, or n) is not known or not estimated.
• Breakeven analysis has been used to solve for the rate of return i*, find the replacement value for a defender, and determine the P, F, A, or salvage value S at which a series of cash flow estimates return a specific MARR.

Methods for Determining Breakeven Quantity

• Direct solution by hand: applicable when only one factor is present (e.g., P, A) or only single amounts are estimated (e.g., P and F).
• Trial and error by hand or calculator: used when multiple factors are present.
• Spreadsheet method: cash flow and other estimates are entered into cells and used in resident functions (PV, FV, RATE, IRR, NPV, PMT, and NPER) or tools (Goal Seek and Solver).

Breakeven Quantity (QBE)

• Breakeven quantity QBE is determined for one parameter or decision variable.
• Examples of variables: design element to minimize cost or production level needed to realize revenues that exceed costs by 10%.