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Prof. Trupti Mishra, School of Management, IIT Bombay Recap from last Session The Long-Run Cost-Output Relations Break-Even Analysis: Linear Cost and Revenue Functions. Break-Even Analysis: Non-Linear Cost and Revenue Function Contribution Analysis Prof. Trupti Mishra, School of Management, IIT Bombay Fixed costs are a constant addition to the variable costs. Total cost line will run parallel to variable cost line. The contribution is the difference between total revenue and variable cost arising out of business decision. Prof. Trupti Mishra, School of Management, IIT Bombay Contribution Analysis Prof. Trupti Mishra, School of Management, IIT Bombay Contribution Analysis OQ, the breakeven level of output, contribution equals fixed cost. Below the output OQ, the total contribution is less than fixed cost- This amount to loss. Beyond output OQ, contribution exceeds fixed cost – the difference is a contribution towards profits resulting from a business decision. Prof. Trupti Mishra, School of Management, IIT Bombay The Profit Volume (PV) Ratio The PV ratio is another useful tool for finding the Break-Even Point (BEP) of sales, especially for multi-purpose firms. The PV ratio is defined by the following formula: PV Ratio = S – V/S x 100 Where S = Selling price; and, V = average Variable cost. Prof. Trupti Mishra, School of Management, IIT Bombay The Profit Volume (PV) Ratio For instance, if the selling price, S = Rs 5 per unit, and average variable cost, V = RSs 4 per unit, then: PV Ratio = 5 – 4/5 x 100 == 20 percent The Break-even point (BEP) in sales value is calculated by dividing the fixed expenses (F) by the PV ratio. BEP (Sales value) = Fixed Expenses/ PV Ratio / = F/S – V/ S Prof. Trupti Mishra, School of Management, IIT Bombay The other methods include reduction in fixed expenses, reduction in variable expenses or having a product mix with greater share of one that assures greater contribution per unit or which has a higher PV ratio. Prof. Trupti Mishra, School of Management, IIT Bombay Margin of Safety Prof. Trupti Mishra, School of Management, IIT Bombay Profit Volume Analysis Chart Cash Break Even Analysis Prof. Trupti Mishra, School of Management, IIT Bombay Limitation of breakeven Analysis Can be applied to only a single product system Cannot be applied where cost and price data cannot be determined beforehand Prof. Trupti Mishra, School of Management, IIT Bombay The curve shows declining trend in long-term average cost of production. Learning curve is different from convention LAC as LAC gives cost of Plant wise production, Learning curve gives average cost of cumulative output., the total output right from the beginning of production of a commodity Session References 21 Managerial Economics; D N Dwivedi, 7th Edition Managerial Economics – Christopher R Thomas, S Charles Maurice and Sumit Sarkar Micro Economics : ICFAI University Press Prof. Trupti Mishra, School of Management, IIT Bombay
