Question

4. Break-even analysis

To be profitable, a firm has recover its costs. These costs include both its fixed and its variable costs. One way that a firm evaluates at what stage it would recover the invested costs is to calculate how many units or how much in dollar sales is necessary for the firm to earn a profit.

Consider the case of Petrox Oil Co.:

Petrox Oil Co. is considering a project that will have fixed costs of $10,000,000. The product will be sold for $41.50 per unit, and will incur a variable cost of $12.80 per unit.

Given Petrox’s cost structure, it will have to sell   units to break even on this project (QBEBE).

Petrox’s marketing and sales director doesn’t think that the firm’s market is big enough for the firm to break even. In fact, she believes that the firm will be able to sell only about 200,000 units. However, she also thinks that the demand for Petrox’s product is relatively inelastic (so the firm can increase the sales price without significantly decreasing the volume of product sold). Assuming that the firm can sell 200,000 units, what price must it set to break even?

$59.66 per unit

$62.80 per unit

$75.36 per unit

$69.08 per unit

What affects the firm’s operating break-even point?

Several factors affect a firm’s operating break-even point. Based on the scenarios described in the following table, indicate whether these factors would increase, decrease, or leave unchanged a firm’s break-even quantity—assuming that only the listed factor changes and all other relevant factors remain constant.

	Increase	Decrease	No Change
The firm depreciates its fixed assets more quickly over a shorter life.
The variable cost per unit decreases.
The amount of debt increases, causing the firm’s total interest expense to increase.

When fixed costs are high, a small decline in sales can lead to a   decline in return on equity (ROE).

Answer 1

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