Introduction to Corporate Finance

11: Risk and Capital Budgeting

required for a project to break even. Breakeven analysis can be expressed in many different ways. For instance,

when a company introduces a new product, it may want to know the level of sales at which incremental net

income turns from negative to positive. When evaluating a new product launch over several years, managers

might ask what growth rate in sales the company must achieve in order to reach a project NPV of zero. Perhaps

the most common form of breakeven analysis focuses on the minimum sales volume needed for a company to

fully cover all costs. The standard equation for the breakeven point (BEP) is found by dividing the fixed costs (FC)

by the contribution margin, which is the sale price per unit (SP) minus variable cost per unit (VC).

Eq. 11.5 (^) ==
−
BEP
SP VC
Fixedcosts
Contributionmargin
Fixedcosts
example
Take another look at Table 11.1 on page 403, which shows
price and cost information for Austral Carbonlite and
Fiberspeed Corp. How many bicycle frames must each
company sell to achieve a breakeven point with EBIT equal
to zero? We can obtain the answer by substituting the data
for each company into Equation 11.5.

( )

=

−

=

Carbonlitebreakevenpoint

$50,000,000

$1,000 $400

8,333frames

( )

=

−

=

Fiberspeedbreakevenpoint

$20,000,000

$1,000 $700

6,667frames

Figures 11.2a and 11.2b illustrate the breakeven point

(BEP) for each company. Despite its $600 contribution

margin, Carbonlite’s high fixed costs result in a breakeven

point at higher sales volume than Fiberspeed’s breakeven

point. This should not surprise us, since we already know

that Carbonlite’s production process results in higher

operating leverage than Fiberspeed’s.

breakeven point (BEP)

The level of sales or

production that a company

must achieve in order to

fully cover all costs. Sales

or production above the BEP

results in profits

contribution margin

The sale price per unit (SP)

minus variable cost per

unit (VC)

How would you determine the

best output mix for a factory

producing at full capacity?

thinking cap

question

FIGURE 11.2A BREAKEVEN POINT FOR AUSTRAL CARBONLITE

The breakeven point (BEP) for Austral Carbonlite is 8333 units, which occurs at the point where its total costs equal its total revenue.

Costs and revenues

$5,000,000

8,333 units Units

Carbonlite has high fixed costs ($5,000,000) and a high contribution margin

($600/frame). The breakeven point is high, but profits grow rapidly after

fixed costs are covered.

Total revenue

Total costs

Fixed costs