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Break-Even Analysis

5 minutes 5 Questions

Break-Even Analysis is a vital tool in Cost Benefit Analysis. It calculates the point at which total costs and total benefits are equal, in other words, the point at which the project breaks even. Every project aims to reach the break-even point as soon as possible and then start turning profits. The implementation of the Break-Even Analysis is quite straightforward. By identifying the fixed costs and variable costs related to a project, the estimated output needed to cover these costs can be calculated. It helps project managers to identify the minimum performance level at which the project becomes profitable, therefore providing a benchmark for the project's success.

Guide on Break-Even Analysis

Break-even analysis is a concept in financial and operational management. It is used by companies to determine the level of sales or units they need to sell to cover their total costs.

Why it is Important:
The break-even analysis is important because it provides vital information to managers about the relationship between costs, volume and profits. Furthermore, it enables a business to understand what it needs to achieve to cover all its costs and start generating income.

What is Break-Even Analysis:
Break-even analysis is a calculating process used by businesses to calculate their break-even point. This point refers to the point at which total cost (both fixed and variable) equals total revenue. A business will neither make a profit nor incur a loss at this point. It's the 'zero profit' point in the profits graphs.

How It Works:
Break-even analysis is performed by identifying the fixed costs, variable costs and understanding the product price per unit. The formula used is:
Break-Even Point (units) = Total Fixed Costs / (Selling Price per unit - Variable Cost per unit).

Exam Tips: Answering Questions on Break-Even Analysis:
In exams, understanding the terms and formula is vital. Make sure to clearly identify fixed costs, variable costs, and the selling price. Often these values need to be extracted from the problem given in the question. Differentiate between Fixed costs which are static and variable costs which change with the volume produced. Show all your calculations clearly for examiner's convenience. It is especially important to correctly interpret the calculated break-even point.

Conclusion:
Understanding the concept of break-even point and how to conduct a break-even analysis can provide great insight into the financial health and performance of a business. It is a simple yet powerful tool that can drive strategic decision making.

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CAPM - Cost Benefit Analysis Example Questions

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Question 1

You are handling an agricultural project with a fixed cost of $700,000. It costs $5 to grow each unit of crop. If each unit is sold at a price of $10, what is the quantity to be grown and sold for the project to reach the break-even point?

Correct Answer: 140000 units

In break-even analysis, it is about determining the point at which revenues equal costs. In this case, the fixed costs are $700,000, the cost of producing a unit is $5, and the selling price of a unit is $10. Therefore, the equation for determining the break-even point is: Fixed Costs / (Selling price per unit - Variable cost per unit). Substituting the given values into the equation: 700000 / (10 - 5). The calculation gives us 140,000 units. This means that 140,000 units have to be grown and sold to cover all costs and reach the break-even point. Hence, the other given quantities: 100000 units, 120000 units, and 150000 units are not correct as to be grown and sold for the project to reach the break-even point, the quantity has to be exactly 140000 units.

Question 2

You're supervising a project with fixed expenses of $1,000,000 and per unit variable expenses of $75. You plan to sell each unit for $150, how much units you need to sell to achieve the break-even point?

Correct Answer: 13334 units

The break-even point is calculated by dividing the fixed costs by the contribution margin per unit. The contribution margin per unit is calculated as selling price per unit minus variable cost per unit. In this case, the selling price per unit is $150 and variable cost is $75, so the contribution margin per unit is $75. The fixed costs are $1,000,000. So, to calculate the break-even point, divide $1,000,000 by $75. This gives 13334 units. The answers '12000 units', '14000 units', and '16000 units' are incorrect because these do not accurately calculate the break-even point based on the provided fixed and variable costs.

Question 3

In a project with a fixed cost of $450,000 and variable cost of $40 per unit, if the selling price is $100 per unit, what is the contribution margin per unit?

Correct Answer: $60

The correct answer is $60 per unit. Here's how we calculate it: 1. Contribution margin = Selling price - Variable cost 2. Selling price = $100 per unit 3. Variable cost = $40 per unit 4. Contribution margin = $100 - $40 = $60 per unit The contribution margin is the amount that contributes to covering fixed costs and then to profit after variable costs are covered. The fixed cost of $450,000 is not relevant for calculating the per-unit contribution margin. The other answers are incorrect: - $50 is not the correct contribution margin, though it is half of the selling price. - $40 is the variable cost, not the contribution margin. - $10 is not the correct calculation and doesn't relate to the difference between fixed and variable costs in this context.

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