Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

IV. Capital Budgeting 11. Project Analysis and

Evaluation

(^386) © The McGraw−Hill
Companies, 2002
of units. In other words, the relationship between total variable cost (VC), cost per unit
of output (v), and total quantity of output (Q) can be written simply as:
Total variable cost Total quantity of output Cost per unit of output
VC Qv
For example, suppose variable costs (v) are $2 per unit. If total output (Q) is 1,000 units,
what will total variable costs (VC) be?
VC Qv
1,000 $2
$2,000
Similarly, if Qis 5,000 units, then VC will be 5,000 $2 $10,000. Figure 11.2 il-
lustrates the relationship between output level and variable costs in this case. In Figure
11.2, notice that increasing output by one unit results in variable costs rising by $2, so
“the rise over the run” (the slope of the line) is given by $2/1 $2.
CHAPTER 11 Project Analysis and Evaluation 357

FIGURE 11.2

Variable

costs ($)

10,000

2,000

Quantity

of output

(sales volume)

0

1,000

= $2

5,000

Output Level and Variable Costs

Variable Costs

The Blume Corporation is a manufacturer of pencils. It has received an order for 5,000 pencils,

and the company has to decide whether or not to accept the order. From recent experience, the

EXAMPLE 11.1