corporate finance

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Joined: Tue May 12, 2015 7:42 am

corporate finance

Postby sun.7674 » Sun Jun 21, 2015 8:44 am

Break even point = (Operating fixed cost + financing fixed cost)/ (Revenue - Variable cost)

My question is why don't we take variable cost in numerator? As i understand by taking it in numerator we would have more clear picture of exactly how many unit of sale we require to cover our total cost. Please explain

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Re: corporate finance

Postby edupristine » Tue Jun 23, 2015 7:11 am

Variable cost varies with sales but fixed cost remains same for the entire production and sales. Break even situation is no profit no loss situation.
Break even points means minimum we have to cover our total cost to remain in the business. And no profit is incurred i.e revenue = FC + VC. If our break even amount is less than total cost that means we have incurred loss and the situation occurs is shut down of the business. That is why, Fixed cost is on numerator because it remains constant and do not changes.
But variable cost increases or decreases on the basis of the demand of the business’ profit. If profit increases VC also increases. That is why it’s at denominator.
Profit = Revenue – Total cost(FC + VC)
Derivation of formula:
Break even point = (Operating fixed cost + financing fixed cost)/ (Revenue - Variable cost)
 Sales(Revenue) = Variable cost + Fixed cost + Profit
 Price * X = (VC * X) + FC + 0
 X(Price - VC) = FC
 X= FC/( Price - VC)
X = Number (Quantity) of units sold.
Break even point = FC/(Revenue - VC). Since, variable cost changes with increase or decrease in no. of units of product. But fixed cost remains constant.

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