2. How it goes……
• Introduction
• Classification
• Cost function relationship
• BEP
• Evaluation of cases
3. COST
• Costs of a firm is incurred to
establish the production unit
and to purchase different
factors of production.
i.e. TC = TFC + TVC
• However, nothing is fixed in
the long run .
4. Why…
.. • The aim of the business is to
maximize profits (Price-
Cost).
• For this managers have to
increase their revenues and
minimize costs.
• The cost of production
provides floor to pricing.
13. Average fixed cost
Average fixed cost (AFC) = TFC/Q
where TFC = fixed cost, Q = total number of
units produced.
Unit fixed costs decline along with volume,
following a rectangular hyperbola. As a
result, the total unit cost of a product will
decline as volume increases.
20. Long run cost curves
The Long run average cost (LRAC or LAC)
curve illustrates - for a given quantity of
production - the average cost per unit
which a firm faces in the long run (i.e.
when no factors of production is fixed).
21. A typical long-run average cost curve
Economies Constant
LRAC
of scale
costs
fig Output OCosts
Diseconomies
of scale
22. Deriving long-run average cost curves: plants of fixed size
fig
SRAC3
1 factory
Costs Output
O
SRAC5
SRAC4
5 factories
4 factories
3 factories
2 factories
SRAC1 SRAC2
23. Deriving a long-run average cost curve: choice of factory size
fig
LRAC
Costs Output
O
24. What is the
break-even
point?
What is the
break-even
point?
Revenues = Costs
Break-even
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Sales (25 x 9,000) 225,000
Variable costs (15 x 9,000) 135,000
Contribution margin 90,000
Fixed costs 90,000
Income from operations 0
Sales (25 x ? units) ?
Variable costs (15 x ? units) ?
Contribution margin 90,000
Fixed costs 90,000
Income from operations 0
25
15
10
Break-even sales (units) =
Fix9e0d,0 c0o0sts
10
9,000 units
Unit contribution margin
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Sales (250 x ? units) ?
Variable costs (145 x ? units) ?
Contribution margin ?
Fixed costs 840,000
Income from operations 0
250
145
105
Break-even sales (units) =
IInn U Unniittss
Fi8x4e0d, 0c0o0sts
105
8,000 units
Unit contribution margin
The unit selling price is 250 and unit variable
cost is 145. Fixed costs are 840,000.
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Sales (25 x ? units) ?
Variable costs (15 x ? units) ?
Contribution margin ?
Fixed costs 840,000
Income from operations 0
250
145
105
Break-even sales (units) =
250
150
100
Fi8x4e0d, 0c0o0sts
100
8,400 units
Unit contribution margin
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The unit selling price is 250 and unit variable
cost is 145. Fixed costs are 840,000.
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Sales ?
Variable costs ?
Contribution margin ?
Fixed costs 600,000
Income from operations 0
Break-even sales (units) =
50
30
20
IInn U Unniittss
Fi6x0e0d, 0c0o0sts
20
30,000 units
Unit contribution margin
A firm currently sells their product at 50 per
unit and it has a related unit variable cost of
30. The fixed costs are 600,000.
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Sales (? units) ?
Variable costs ?
Contribution margin ?
Fixed costs 200,000
Income from operations 0
In
Units
75
45
30
In
Units
Fixed costs are estimated at 200,000, and the
desired profit is 100,000. The unit selling price
is 75 and the unit variable cost is45. The firm
wishes to make a100,000 profit.
33. TTTTaaaarrrrggggeeeetttt PPPPrrrrooooffffiiiitttt In
Sales (? units) ?
Variable costs ?
Contribution margin ?
Fixed costs 200,000
Income from operations 0
Sales (units) =
In
Units
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ttoo ““IInnccoommee ffrroomm
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10,000 units
Unit contribution margin
30
Units
75
45
30
34. 75
45
30
TTTTaaaarrrrggggeeeetttt PPPPrrrrooooffffiiiitttt
Sales (10,000 units x 75) 750,000
Variable costs (10,000 x 45) 450,000
Contribution margin 300,000
Fixed costs 200,000
Income from operations 100,000
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36. CCoosstt--VVoolluummee--PPrrooffiitt CChhaarrtt
SSaalleess aanndd CCoossttss ((rrss000000))
0
Units of Sales (000)
500
450
400
350
300
250
200
150
100
50
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
6600%%
Total Sales
Variable
Costs
1 2 3 4 5 6 7 8 9 10
37. CCoosstt--VVoolluummee--PPrrooffiitt CChhaarrtt
SSaalleess aanndd CCoossttss ((rrss000000))
0
40%
1 2 3 4 5 6 7 8 9 10
Units of Sales (000)
500
450
400
350
300
250
200
150
100
50
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
6600%%
Contribution
Margin
100%
60%
40%
38. CCoosstt--VVoolluummee--PPrrooffiitt CChhaarrtt
SSaalleess aanndd CCoossttss ((rrss000000))
0
TToottaall
CCoossttss
1 2 3 4 5 6 7 8 9 10
Units of Sales (000)
500
450
400
350
300
250
200
150
100
50
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
FFiixxeedd CCoossttss
100%
60%
40%
39. CCoosstt--VVoolluummee--PPrrooffiitt CChhaarrtt
SSaalleess aanndd CCoossttss ((rrss000000))
500
450
400
350
300
250
200
150
100
50
0
Break-Even Point
1 2 3 4 5 6 7 8 9 10
Units of Sales (000)
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
100%
60%
40%
100,000
20
= 5,000 units
40. CCoosstt--VVoolluummee--PPrrooffiitt CChhaarrtt
SSaalleess aanndd CCoossttss ((rrss000000))
0
Operating Profit Area
Units of Sales (000)
500
450
400
350
300
250
200
150
100
50
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
Unit selling price 50
Unit variable cost 30
Unit contribution margin 20
Total fixed costs 100,000
100%
60%
40%
Operating Loss Area
42. PAST SCENARIO
Earlier Models of PS4 incurred Losses.
PS3 was launched in 2 types of models
Manufacturing Cost was $805 and $840
Selling Price was $499 and $599
(Per Unit)
Loss of $305 and $245
(Per Unit)
43. REASON FOR LOSSES
Hardware parts Cost: Custom chips and
others. Hardware parts weren’t cheap
during that period of time.
Sales:
Low Price compare to cost.
44. PRESENT SCENARIO
Abandoned custom components. Decided to use readily
available components.
In turn adequate supply . Hardware prices dropped significantly
after 2006.
Manufacturing Cost was $381
Selling Price was $399
(Per Unit)
Profit of $18
(Per Unit)
High Sales due to low selling price ( just above break even)
45. Toyota
Three competitors
Toyota Honda Nissan
TOYOTA
has bigger portion of share than others in Japan
Aim of Toyota:
Lower the Break even point by Improving
manufacturing process
46. Problem
Financial Crisis i.e. dropping Yen to dollars
(80 yen to $1)
&
Low Sales in domestic market
Possible Solution
Shifting production overseas or Lower
Production Cost
(Nissan) (Toyota)
47. Strategy to lower cost of
production
They tried to Aim 70% capacity utilization
(12000 units daily).
Assumes yen value to dollars of 90 yens to $1
(Preparing for worst case in advance)
Based on this they build production strategy
(flexible)
Changed Layout of production ( more
compact)
48. Forecasted fall of sale 17%
( more than predicted overall automobile
market in Japan 9.9% )
Plans to produce 3.1 million units
and
sell 58% overseas.
49. Expected Result
40% less capital spending
Annual expenditure $8.4 billion
( half of previous year)
Lower break even point as a result by
Increasing sales by overseas sale