Linear Break Even Analysis

Fig (a) shows a linear break even relationship. The vertical axis depicts total revenues and total costs whereas output is shown on the horizontal axis. The slope of the TR curve refers to the constant price of Rs 10 per unit at which the firm can sell its output. The TC curve indicates the total fixed costs (TFC) of Rs 200 (the vertical intercept) and a constant AVC of Rs 5 (the slope of the TC curve).

Total cost curve is a straight line because AVC is taken as constant. Since AVC is constant, the extra cost of extra unit must be constant too and equal to AVC. This is often the case for many firms for small changes in output or sales. The firm breaks even at 40 units of output (point B) where TR is equal to the 'I'C. The firm incurs operating losses at smaller outputs (since TC > TR) and earns operating profits at higher output levels (since TR > TC).

The break even chart is a flexible tool to quickly analyse the effect of changing conditions on the firm. For example, an increase in the price of the commodity can be shown by increasing the slope of the TR curve. An increase in TFC of the firm can be depicted by an increase in vertical intercept of the TC curve and an increase in the AVC by an increase in the slope of the TC Curve. The chart will then show the change in the break-even point of the firm and the profit or losses at other output or sales levels.

Cost-volume profit analysis can be calculated algebraically. TR is the price per unit times the quantity of output or sales (Q)

TR=P.Q

TC = TFC + TVC

Since TVC = (AVC) (Q)

TC = TFC + (AVC) (Q)

Setting TR = TC and substituting Q_B (breakeven output) for Q we have (P) (Q_B) = TFC + (AVC) (Q_B)

Solving for break even output, we get

(P) (Q_B) - (AVC) (Q_B) = TFC

(Q_B) (P - AVC) = TFC

Q_B = TFC / P-AVC

The equation can be modified to calculate the contribution margin towards the fixed costs and desired amount of profit (11).

           The profit volume (PV) ratio can also be used to find the BEP for sales for multi product firms. It can be calculated with the help of a formula

                             PV ratio=[-(S-V)/S]¹⁰⁰

Where S is the selling price and V the variable cost, The PV ratio is helpful in making choice of a product. If there is no time constraint, then a product with a higher PV ratio should be selected. On the other hand, PV ratio per time unit is taken as the basis of choice in case of time constraint.

The linear approach to profit contribution has been criticised as it considers both price and AVC constant. The price assumption is not realistic for many firms, because they may not sell all they produce at the going price.

Especially firms, where sales are large relative to the size of market, may have to reduce price to sell more output. For some firms, the assumption of constant AVC may be unrealistic. Also, empirical studies suggest that the TC function is often close to linear, as long as the firm is not operating at or close to capacity.

However, if the price and AVC are roughly constant, at least over the limited range of output relevant to the problem, breakeven analysis is a useful tool for managerial decisions. But care and judgement are required in its application. 

Managerial Economics Tutoring - Assignment Help

Our online managerial economics experts are here for your help. Expertsmind.com online assignment help-homework help brings you high grade in your courses and examination, We at Expertsmind.com offers managerial economics assignment help, managerial economics homework help and projects help. We offer complete package of managerial economics online tutoring for 24x7 hours.

ExpertsMind.com - Linear Break Even Analysis Assignment Help, Linear Break Even Analysis Homework Help, Linear Break Even Analysis Assignment Tutors, Linear Break Even Analysis Solutions, Linear Break Even Analysis Answers, Break Even Analysis Assignment Tutors