Corporate Finance

Risk Analysis in Capital Investments 
 215

Exhibit 11.3 contd.

Year 1 1.1 1.2 0.9 0.8

8 268 294.80 321.6 241.20 214.4

9 248 272.80 297.6 223.20 198.4

10 1,027 1,129.70 1,232.4 924.30 821.6

124.87 278.36 431.84 (28.62) (182.11)

NPV

431.84

(28.62) (182.11)

278.36

124.87

(400.00)

(200.00)

0.00

200.00

400.00

600.00

1 1.1 1.2 0.9 0.8

Proportion of base case

Within the relevant output range, some expenses like depreciation or managerial remuneration remain
whether the firm makes use of the capacity or not. Such costs are fixed costs. Some costs (like the cost of raw
material) vary with the level of activity. Such costs are called variable costs. Note that, over an extended
period of time, all costs are variables. For example, managers can be relieved from service or equipment could
be disposed off. The denominator in the above equation (Selling price – Variable cost/unit) is called contri-
bution (towards recovering fixed cost and profits). Accounting the BEP for the BHEL project is shown in
Exhibit 11.4. The higher the breakeven point, the higher is the risk that the firm will incur a loss.

Exhibit 11.4 Accounting BEP as percentage of the installed capacity

(Rs lac)

Sales 2,713
Less: Variable costs

• Raw materials, dyes & chemicals, stores & spares 1,839


• Utilities 127


• Interest of working capital borrowing 101

2,158

Contribution = Sales – Variable costs 555
Fixed costs:

• Wages & salaries 82


• Factory & plant overheads 25


• Administrative expenses 35


• Interest on term loan 101


• Other bank charges 7


• Depreciation 118

368

BEP = Contribution
Fixed cost
× Capacity utilization (percent)

= 555

368

x 100 percent

= 66.33 percent

Note: All figures relate to a normal year of operation.