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Cost Volume/ Break Even Analysis

Location Decision Analysis: Cost-Volume & Break-Even Analysis

Locational Cost-Volume Analysis

Concept: A technique for comparing location alternatives based on their costs. It helps determine which location offers the lowest cost for a given production volume.

Method:

  1. Identify Costs: Determine fixed costs (independent of production volume) and variable costs (per unit) for each location.
  2. Graph Costs: Plot total costs against production volume for each location.
  3. Compare Costs: Select the location with the lowest total cost at the expected production volume.

Graphic Approach Advantage: Visualizes the volume ranges where each location is most cost-effective.

Example:

  • Locations: Athens, Brussels, Lisbon
  • Fixed Costs: $30,000, $60,000, $110,000
  • Variable Costs (per unit): $75, $45, $25
  • Volume: 2,000 units

Calculations:

  • Total Cost = Fixed Cost + (Variable Cost per Unit * Volume)

  • Athens: $30,000 + ($75 * 2,000) = $180,000

  • Brussels: $60,000 + ($45 * 2,000) = $150,000

  • Lisbon: $110,000 + ($25 * 2,000) = $160,000

For a volume of 2,000 units, Brussels has the lowest cost.

Practical Application: Consider a company looking to open a manufacturing facility. They have three options:

  • Location X: Fixed costs are $150,000, Variable Cost $10/unit.
  • Location Y: Fixed costs are $350,000, Variable Cost $8/unit.
  • Location Z: Fixed costs are $950,000, Variable Cost $6/unit

If expected demand is 130,000 units, the cost for each would be

  • Location X: 150,000+ (10* 130,000) = 1,450,000
  • Location Y: 350,000+(8* 130,000) = 1,390,000
  • Location Z: 950,000+(6* 130,000) = 1,730,000

Location Y would be the most suitable at 130,000 units.

Break-Even Analysis

Concept: Determines the production volume at which total revenue equals total cost. It's the point where neither profit nor loss occurs.

Formula (Units):

  • Break-Even Point (BEP) = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)
  • BEP = F / (S-V)

Where: * F = Fixed Costs * S = Selling Price per Unit * V = Variable Cost per Unit

Practical Example: A new service company faces an initial investment of $200,000, the fixed costs associated with setup. Their variable cost per client is $25, and they are selling their service at $125 per client.

  • BEP = $200,000 / ($125-$25)
  • BEP = $200,000/100
  • BEP = 2,000 clients

The company needs to acquire 2,000 clients to break even.

  • Cost-Volume Analysis: Helps identify the lowest-cost location at a given production volume.
  • Break-Even Analysis: Determines the minimum output needed to cover costs.
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