Sunk Cost

Money already spent and permanently lost. Sunk costs are past opportunity costs that are partially (as
salvage, if any) or totally irretrievable and, therefore, should be considered irrelevant to future decision
making.

A drug manufacturing company A invests $ 2,50,000/- for many years for the R&D on a new drug for hair
growth. When the company launched this product in the market, due to some side effects faced by many
patients, doctors stopped recommended that pill to their patients, this forced the company to stop the
production of that pill. In this case, the $ 2,50,000/- has become a sunk cost, so it should not be
considered in any decision for this product in the future.

Opportunity cost
Opportunity cost is the profit lost when one alternative is selected over another. The concept is useful
simply as a reminder to examine all reasonable alternatives before making a decision. For example, you
have $1,000,000 and choose to invest it in a product line that will generate a return of 5%. If you could
have spent the money on a different investment that would have generated a return of 7%, then the 2%
difference between the two alternatives is the foregone opportunity cost of this decision.

Opportunity cost does not necessarily involve money. It can also refer to alternative uses of time. For
example, do you spend 20 hours learning a new skill, or 20 hours reading a book?

Cash Cost
When a company sells something such as a stock to raise quick profits.

A cash cost is a cash transaction, or cash flow. If a company purchases an asset, it realizes a cash cost.

Book cost
A book cost is not a cash flow, but it is an accounting entry that represents some change in value. When a
company records a depreciation charge of $4 million in a tax year, no money changes hands. However,
the company is saying in effect that the market value of its physical, depreciable assets has decreased by
$4 million during the year.

In other words, the expenses which are not payable in cash, but rather their provisions are made in the
books of accounts while finalizing the profit and loss statement, is called as book costs.

Life Cycle Cost

Life cycle costing, LCC, is the process of economic analysis to assess the total cost of ownership of a
product, including its cost of installation, operation, maintenance, conversion, and/or decommission.
Calculating the total Life Cycle Cost
Costs Involved

• Initial Cost (Cic)

• Delivery and Installation Costs (Cinst)

• Energy Cost (Ce)

• Operational cost (Co)

• Maintenance Cost (Cm)

• Downtime Costs (Cs)

• Decommissioning/disposal costs (Cd)

Formula
LCC = Cic + Cinst + Ce + Co + Cm + Cs + Cd

Break-Even Point Analysis

A decision-making aid that enables a manager to determine whether a particular volume of sales will
result in losses or profits.

• Revenue is the total income received.

• Profit is the money you have after subtracting fixed and variable cost from revenue.

The optimal price is that price point at which the total profit of the seller is maximized. When the
price is too low, the seller is moving a large number of units but is not earning the highest possible
aggregate profit. When the price is too high, the seller is moving too few units at a high margin per unit,
and so achieves a lesser total profit figure.

What it can be used for?

• Monthly expenses- use it to see if your income is more than your expenses

• Determine minimum price product can be sold for

• Determine optimum price product can be sold for

The Break-Even Point (BEP) Formula

Break-Even Point Chart

Let’s say you own a business selling burgers
It costs Rs 7.00 to make one burger

That’s your V or Variable cost!

You sell each burger for Rs 12.50.

That’s your P or price per unit!

Your cost for rent, utilities, overhead, etc... Is

Rs 100,000 per month.

That's your F or fixed cost!

Answer
Given: V = Rs 7 P = Rs 12.50

F = Rs 100,000

Solution:

X = F / (P – V)

X = 100,000 / (12.50 - 7)

X = 100,000 / (5.5)

X = 18, 181.818

X ≈ 18, 182

To breakeven you would need to sell 18,182 burgers.

Sample Problem # 2
Try out this problem for your self

• You own a lemonade stand.

• It costs you Rs 1.50 to make cup of lemonade

• You sell your lemonade for Rs 5.00.

• It cost you Rs 5,000 to rent for the space of your lemonade stand.

• How many cups of lemonade do you have to sell to breakeven?

Limitations of BEP Analysis
• Assumes that sales prices are constant at all levels of output.

• Assumes production and sales are the same.

• Break even charts may be time consuming to prepare.

• It can only apply to a single product or single mix of products.

Conclusion
• A Breakeven Analysis is a simple tool to use to determine if you have priced your product correctly.

• A Breakeven Analysis helps you calculate how much you need to sell before you begin to make a profit.
You can also see how fixed costs, price, volume, and other factors affect your net profit.