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Chapter 11: Breakeven and

Sensitivity Analysis
Tsui Ping Chung
Tsui-Ping

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The goal
y The objective of Chapter 11 is to illustrate breakeven

and sensitivity methods for investigating variability in


outcomes of engineering projects.

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To this point we have assumed a high


degree of confidence in estimated values.
y The degree of confidence is sometimes called assumed

certainty, and decisions made on the basis of this kind of


analysis
y are called decisions under certainty.
y
y In virtually all situations, ultimate economic results are
unknown.
y Breakeven and sensitivity analysis are used to help
understand how our decision might be affected if our
original estimates are incorrect.

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The breakeven point is the value of a key


factor at which we are indifferent between
y be do nothing).
g )
two alternatives ((one may

The breakeven point is the value of y where

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Example 11-1

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Example 11-2

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Common factors to consider for breakeven


analysis.
y annual revenue and expenses
y rate of return
y market (or salvage) value
y equipment life
y capacity utilization

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Should Jim sell his gas-guzzler()?


y Jim
Jims1998
s1998 minivan is quite functional,
functional but it only

averages 20 miles per gallon (mpg). He has found a


somewhat newer vehicle (roughly the same functionality)
that averages 26 mpg. He can sell his current minivan for
$2800 and purchase the newer vehicle for $4,000.
$4 000
Assume a cost of gasoline $4.00 per gallon How many
miles per year must Jim drive if he wants to recover his
investment in three years? Assume an interest rate of
6% zero salvage value for either vehicle after three
6%,
years, and identical maintenance cost.
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Gas-guzzler solution
Current minivan
N vehicle
New
hi l
Equating these, and solving for x, we find

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We use sensitivity
y analysis
y to see what
happens to project profitability when the
estimated value of study factors are
changed.
y What if expenses are 10% higher than expected

is the project profitable?


y What if sales revenue is 15% lower than expected?
y What
h change
h
in
i either
i h expenses or revenues will
ill
cause the project to be unprofitable (decision
reversal)?
l)?
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Reconsidering Jim's gas-guzzler.


y Considering that Jim drives about 10
10,000
000 miles per year,
year our

previous analysis would indicate that he should purchase the


vehicle
ve
c e that
t at gets better
ette mileage.
eage. However,
oweve , w
what
at if gas pprices
ces
drop by 10%? Should Jim still sell his gas-guzzling minivan?

So, if gas prices drop by 10%, Jim should keep his minivan.
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Spreadsheets are very useful in performing


sensitivity analysis.
y Formulas easily reflect changes in parameter

values.
y Tables
T bl andd plots
l t can provide
id quick
i k answers andd
visual cues to the effect of changes.
y A spider plot can be especially useful in sensitivity
studies.
y It can be useful to examine more than one
alternative on a plot, or to examine sensitivity of
incremental cash flows.
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[Note that the steeper the curve, the


more sensitive is the PW to the factor.]
factor ]
Example 11.5

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Figure 11-6

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Spreadsheet Solution for Example 11-6

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Changing the value of more than one factor


at a time.
y To this point we have only looked at changes in

one factor at a time.


y In
I reality,
lit eachh factor
f t considered
id d can change,
h
so it
is useful to look at the effect of simultaneous
changes
h
iin factors
f t off interest.
i t
t
y One way to accomplish this is to use the
Optimistic-Most Likely-Pessimistic (O-ML-P)
technique.

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Optimistic-Most Likely-Pessimistic
y Establish optimistic (the most favorable),
favorable) most likely
likely, and
y

y
y
y

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pessimistic (the least favorable) estimates for each factor.


The optimistic condition, which should occur about 1 time
out of twenty, is when all factors are at their optimistic
levels. Similarly for pessimistic condition.
The most likely condition should occur roughly 18 times
out of 20.
Perform EW calculations under each condition for insight
into the sensitivity of the solution.
The results can be seen on a spider plot for further insight

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Example 11.7

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