breakeven analysis

Analysis
The process of breakeven analysis examines the relationship between revenue and costs for different factors of production. The main emphasis is in determining the
number of units and the sales volume at which the company will recover its costs. At this level of production and sales the company’s profits are zero. By examining
this initial breakeven point companies can analyze the risk of a particular project as well as any potential profits that can be garnered.

In a spreadsheet analysis of breakeven problem, the advantage is that many “what if” scenarios can be examined without lengthy computation times and fear of
computational errors are virtually eliminated. In addition, by taking advantage of the graphical capabilities of spreadsheet programs, the results can be shown
graphically as well as numerically.
A well designed spreadsheet would accommodate cells for the input data such as fixed costs, variable cost per unit, price per unit, etc. It is possible to even provide
for raw observational data to be used such as sales volume, total cost, and quantity. However, we will leave that model for a subsequent analysis. In addition, the
model should provide an output range to include relevant factors like break even quantity, break even dollars, and target profit, etc. The model should be designed
such that as the input values are changed the corresponding output values are automatically modified to reflect these changes. This process involves setting up
relative formulas for the computation of break even quantity, break even dollars, and projected profits. Finally, the model should provide a graphical representation
of the problem. This would best be represented as a linear graph of revenue, cost, and profit displayed as a function of quantity.
Some useful hints for creating a well-designed break even computer model include:
The basic computational equation for breakeven quantity is: Break Even Quantity = Fixed Costs / (Price per unit – Variable Cost per Unit)
Break even dollars can be computed using the revenue or cost formula evaluated at the break even quantity.
Projected profits can be evaluated using the profit function evaluated at the planned production level.
Each of the above formulas should be written with relative references to the cells of the spreadsheet that contain the input data of price per unit, variable cost per
unit, fixed costs, and planned production level.
Break Even Analysis Project – Saint Francis Hospital
Saint Francis Hospital has an operating room used only for eye surgery. The annual cost of rent, heat, and electricity for the operating room and its equipment is
$275,000 , and the annual salaries for the people who staff this room total $1,270,000. These costs are the same regardless how many surgeries are performed. Each
surgery performed requires the use of $1,375 worth of medical supplies and drugs. To promote goodwill, every patient receives a bouquet of flowers the day after
surgery. In addition, all patients require dark glasses, which the hospital provides free-of-charge. It costs the hospital $55 for each bouquet of flowers and $25 for
each pair of glasses. The hospital receives a payment of $3,500 for each eye operation performed. Last year the hospital performed 950 operations and plans to continue
at this level of production.
Identify the revenue per case (price per unit) and the annual fixed and variable costs for running the operating room. Set up your spreadsheet so that theses inputs
can readily be changed. Set up a output range to calculate the break even quantity and dollar amount for total revenue and costs. Also set up a output range to display
the projected profits resulting from different levels of production. How many eye operations must the hospital perform each year in order to break even? What would the
annual profits be if they perform 950 operations each year?
One of the nurses has just learned about a machine that would reduce the cost of medical supplies needed by $580 per patient. It can be leased for $475,000 annually.
Keeping in mind the financial costs and benefits, advise the hospital on whether or not they should lease this machine. Use the spreadsheet to identify the breakeven
point and the level of profit associated with 950 operations per per year. Modify the fixed and variable costs as appropriate and examine the break even quantity and
profits again.
An advertising agency has proposed to the hospital’s president that she spend $10,000 per month on television and radio advertising to persuade people that Saint
Francis Hospital is the best place to have any eye surgery performed. The advertising firm estimates that such publicity would increase business by 30 operations per
month. If they are correct, what impact would this advertising have on hospital’s profit? What would happen to the breakeven point? In case the advertising agency is
being overly optimistic, what would the decision be if the advertising campaign only increased the number of operation per month by 5? What is the maximum amount the
Hospital would be willing to pay for the advertising if the ads generated 30 additional operations each month? Consider this option independent of the machine purchase
described above.
Assuming the hospital decided to use the advertising program, should the hospital then also purchase the machine? What impact do these decisions have on profits and
risk for the hospital?
Prepare a written report summarizing your results and recommendations. Include an explanation of the effects of changing the price, variable cost, and fixed costs on
the break even point and profits. The report should include printouts of the various spreadsheets and graphs to support your conclusions
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