cost and profit analysis

1. Cost and profit
analysis
Vibha Bhan Rahul
Babar
Dhanashree Prasad
Bhojane

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.

5. Classification of
cost

6. COST RELATIONSHIP

7. fig
100
80
60
40
20
0
Total costs for firm X
TFC
Output
(Q)
01234567
TFC
(rs)
12
12
12
12
12
12
12
12
0 1 2 3 4 5 6 7 8

8. fig
100
80
60
40
20
0
Total costs for firm X
TFC
Output
(Q)
01234567
TFC
(rs)
12
12
12
12
12
12
12
12
TVC
(rs)
0
10
16
21
28
40
60
91
0 1 2 3 4 5 6 7 8

9. fig
100
80
60
40
20
0
Total costs for firm X
TVC
Output
(Q)
01234567
TFC
(rs)
12
12
12
12
12
12
12
12
TVC
(rs)
0
10
16
21
28
40
60
91
TFC
0 1 2 3 4 5 6 7 8

10. fig
100
80
60
40
20
0
Total costs for firm X
TVC
Output
(Q)
01234567
TFC
(rs)
12
12
12
12
12
12
12
12
TVC
(rs)
0
10
16
21
28
40
60
91
TFC
0 1 2 3 4 5 6 7 8

11. fig
100
80
60
40
20
0
Total costs for firm X
TVC
TFC
Output
(Q)
01234567
TFC
(rs)
12
12
12
12
12
12
12
12
TVC
(rs)
0
10
16
21
28
40
60
91
TC
(rs)
12
22
28
33
40
52
72
103
0 1 2 3 4 5 6 7 8

12. fig
100
80
60
40
20
0
Total costs for firm X
TC
Output
(Q)
01234567
TFC
(rs)
12
12
12
12
12
12
12
12
TVC
(rs)
0
10
16
21
28
40
60
91
TC
(rs)
12
22
28
33
40
52
72
103
TVC
TFC
0 1 2 3 4 5 6 7 8

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.

14. Average Fixed costs
Q
Costs
AFC
O

15. Average variable cost
Average variable cost (AVC) is the TVC of a firm
divided by the total units of output (Q).
AVC = TVC/Q
Q
costs
Y
AVC
O

16. Average cost
Average cost (AC) is the TC of a firm divided by
the total units of output (Q).
AC = TC/Q = AFC + AVC
Q
costs
Z
AC
O

17. Marginal Cost
The additional cost incurred to produce one
additional unit of output is called the
Marginal Cost (MC).
MC = ΔTC/ ΔQ

18. Output (Q) Costs (rs)
MC
MMaarrggiinnaall ccoossttss

19. Short run average cost curve
Output
(Q)
Costs
AVC
AFC
MC
AC
z
y

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

25. CCCCaaaallllccccuuuullllaaaattttiiiinnnngggg tttthhhheeee BBBBrrrreeeeaaaakkkk----EEEEvvvveeeennnn PPPPooooiiiinnnntttt
Sales (? units) ?
Variable costs ?
Contribution margin 90,000
Fixed costs 90,000
Income from operations 0
At the break-even point, fixed
costs and the contribution
At the break-even point, fixed
costs and the contribution
margin are equal.
margin are equal.
25
15
10

26. CCCCaaaallllccccuuuullllaaaattttiiiinnnngggg tttthhhheeee BBBBrrrreeeeaaaakkkk----EEEEvvvveeeennnn PPPPooooiiiinnnntttt
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
PPPPRRRROOOOOOOOFFFF!!!!
IInn U Unniittss

27. CCCCaaaallllccccuuuullllaaaattttiiiinnnngggg tttthhhheeee BBBBrrrreeeeaaaakkkk----EEEEvvvveeeennnn PPPPooooiiiinnnntttt
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.

28. CCCCaaaallllccccuuuullllaaaattttiiiinnnngggg tttthhhheeee BBBBrrrreeeeaaaakkkk----EEEEvvvveeeennnn PPPPooooiiiinnnntttt
NNeexxtt,, aassssuummee
vvaarriiaabbllee ccoossttss iiss
iinnccrreeaasseedd bbyy 55..
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
NNeexxtt,, aassssuummee
vvaarriiaabbllee ccoossttss iiss
iinnccrreeaasseedd bbyy 55..
IInn U Unniittss
The unit selling price is 250 and unit variable
cost is 145. Fixed costs are 840,000.

29. CCCCaaaallllccccuuuullllaaaattttiiiinnnngggg tttthhhheeee BBBBrrrreeeeaaaakkkk----EEEEvvvveeeennnn PPPPooooiiiinnnntttt
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.

30. CCCCaaaallllccccuuuullllaaaattttiiiinnnngggg tttthhhheeee BBBBrrrreeeeaaaakkkk----EEEEvvvveeeennnn PPPPooooiiiinnnntttt
MMaannaaggeemmeenntt iinnccrreeaasseess
tthhee sseelllliinngg pprriiccee ffrroomm
MMaannaaggeemmeenntt iinnccrreeaasseess
tthhee sseelllliinngg pprriiccee ffrroomm
Sales ?
Variable costs rrss5500 ttoo rrss6600..
?
Contribution margin ?
Fixed costs 600,000
Income from operations 0
Break-even sales (units) =
50
60
30
20
30
IInn U Unniittss
Fi6x0e0d, 0c0o0sts
20,000 units30
Unit contribution margin
rrss5500 ttoo rrss6600..

31. SSuummmmaarryy Summary ooff of EEffffeeccttss ooff CChhaannggeess oonn
BBrreeaakk--EEvveenn PPooiinntt

32. TTTTaaaarrrrggggeeeetttt PPPPrrrrooooffffiiiitttt
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
TTaarrggeett pprrooffiitt iiss
uusseedd hheerree ttoo rreeffeerr
ttoo ““IInnccoommee ffrroomm
ooppeerraattiioonnss..””
TTaarrggeett pprrooffiitt iiss
uusseedd hheerree ttoo rreeffeerr
ttoo ““IInnccoommee ffrroomm
ooppeerraattiioonnss..””
Fixe2d0 0c,o0s0t0s ++ t1a0rg0e,0t 0p0rofit
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
PPrrooooff tthhaatt ssaalleess ooff 1100,,000000 uunniittss
wwiillll pprroovviiddee aa pprrooffiitt ooff 110000,,000000..

35. Graphic Approach to
Cost-Volume-Profit
Analysis

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

41. Sony Play station ( Case study )
PS3 PS4
2006 2013

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