CFA Level 1

AAA

Corporate Finance - Sales and Leverage

A company's costs include both fixed and variable costs. The breakeven quantity of sales is the sales amount where both fixed and variable costs are covered. Breakeven quantity of sales:

Formula 11.17

BEQ= Fixed Costs
Price - Variable Costs
Example:
Assume Newco's product costs for two different products are the figures below. Calculate Newco's breakeven quantity of sales and determine the company's gain or loss at various sales levels for each product.
Figure 11.11: Newco's cost breakdown for Product 1

Figure 11.12: Newco's cost breakdown for Product 2

Answer:

Product 1:
For Newco, the breakeven quantity of its product is:
BEQ = $2,400,000/($50 - $20) = 80,000 units

At various sales levels, the company's gains or losses are as follows:

Figure 11.13: Sales analysis


Units Sold Sales/(Loss)
20,000 ($1,800,000)
40,000 ($1,200,000)
60,000 ($600,000)
80,000 $0
100,000 $600,000
120,000 $1,200,000
140,000 $1,800,000



Product 2:
For Newco, the breakeven quantity of its product is:
BEQ = $1,800,000/($50 - $20) = 60,000 units

At various sales levels, the company's gains or losses are as follows

Figure 11.14: Sales analysis

Units Sold Sales/(Loss)
20,000 ($1,200,000)
40,000 ($600,000)
60,000 $0
80,000 $600,000
100,000 $1,200,000
120,000 $1,800,000
140,000 $2,400,000


Look Out
Note from the examples above, the higher a company's fixed costs, if all else is constant, the higher a company's breakeven quantity.
Effects of Debt on the Capital Structure
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