Principles of Managerial Finance

510 PART 4 Long-Term Financial Decisions

3. Because the firm is assumed to be a single-product firm, its operating breakeven point is found in terms of unit
   sales, Q. For multiproduct firms, the operating breakeven point is generally found in terms of dollar sales, S. This is
   done by substituting the contribution margin, which is 100% minus total variable operating costs as a percentage of
   total sales, denoted VC%, into the denominator of Equation 12.3. The result is Equation 12.3a:
   S (12.3a)
   This multiproduct-firm breakeven point assumes that the firm’s product mix remains the same at all levels of sales.

FC

1 VC%

As noted above, the operating breakeven point is the level of sales at which all

fixed and variable operating costsare covered—the level at which EBIT equals

$0. Setting EBIT equal to $0 and solving Equation 12.2 for Qyield

Q (12.3)

Qis the firm’s operating breakeven point.^3

EXAMPLE Assume that Cheryl’s Posters, a small poster retailer, has fixed operating costs of

$2,500, its sale price per unit (poster) is $10, and its variable operating cost per

unit is $5. Applying Equation 12.3 to these data yields

Q500 units

At sales of 500 units, the firm’s EBIT should just equal $0. The firm will have

positive EBIT for sales greater than 500 units and negative EBIT, or a loss, for

sales less than 500 units. We can confirm this by substituting values above and

below 500 units, along with the other values given, into Equation 12.1.

The Graphical Approach

Figure 12.1 presents in graphical form the breakeven analysis of the data in the

preceding example. The firm’s operating breakeven point is the point at which its

total operating cost—the sum of its fixed and variable operating costs—equals

sales revenue. At this point, EBIT equals $0. The figure shows that for sales

below500 units, total operating cost exceeds sales revenue, and EBIT is less than

$0 (a loss). For sales abovethe breakeven point of 500 units, sales revenue

exceeds total operating cost, and EBIT is greater than $0.

Changing Costs and the Operating Breakeven Point

A firm’s operating breakeven point is sensitive to a number of variables: fixed

operating cost (FC), the sale price per unit (P), and the variable operating cost per

unit (VC). The effects of increases or decreases in these variables can be readily

seen by referring to Equation 12.3. The sensitivity of the breakeven sales volume

(Q) to an increasein each of these variables is summarized in Table 12.3. As

might be expected, an increase in cost (FCor VC) tends to increase the operating

breakeven point, whereas an increase in the sale price per unit (P) decreases the

operating breakeven point.

$2,500



$5

$2,500



$10$5

FC



PVC