5.5 IB Business - Break Even

Cycle4U is a bicycle shop in the town. The fixed cost of the company is $14 000 per month. The contribution per unit is $200. Using this information, if the target profit is $20 000, calculate how many bicycles the shop needs to sell.

• 70

• 100

• 170

• 200

Answer explanation

Target profit output = (fixed cost + target profit) ÷ contribution per unit
= ($14 000 + $20 000) ÷ $200 
= 170

Jan runs an ice cream shop. Jan needs to sell 10,000 units to break even. Jan sold 10,250 units this month. Calculate Jan’s margin of safety.

• 100

• 250

• 500

• 1,000

Answer explanation

Margin of safety = 10 250 – 10 000 
= 250

Leila runs an ice cream shop. Each unit of ice cream has a variable cost of $1.50 and sells for $2.00. Leila’s fixed cost for operating the shop is $5000 per month. How many ice creams does Leila need to sell to break even?

• 2,000

• 5,000

• 8,000

• 10,000

Ali runs an ice cream shop. Each unit of ice cream has a variable cost of $0.50 and sells for $2.00. Ali’s fixed cost for operating the shop is $5000 per month. What is the contribution per unit of ice cream?

• • $0.50

• • $1.50

• • $2.00

• • $2.50

The point where a business makes neither profit nor loss occurs when:

• TR = TC

• TR > TC

• TC > TR

• TR = TC or TR > TC

Answer explanation

When total costs and total revenue are equal, it means the business is breaking even. In other words, the sales revenue has covered all the cost incurred. 

Which of the following terms indicates that total revenue is greater than total costs?

• Profit

• Loss

• Break-even

• Margin of safety

Answer explanation

When total revenue is greater than total costs, a business will make a profit. When total revenue is lower than total costs, a business will make a loss. When total revenue and total costs are equal, a business breaks even, meaning that both their profit and loss are zero. The margin of safety is the difference between the break-even point and the actual output.  

A firm has fixed costs of 10,000, total variable costs of 30,000, and sells each product for $2. Therefore, it needs to sell 20,000 products to break-even.

• True

• False

Which of the following is a limitation of using break-even analysis? 

• It can be used to evaluate company capacity.

• It assumes that all customers pay the same price.

• It allows companies to set sales targets.

• It can be used to see how changes in costs may affect profit.

Answer explanation

Although break-even analysis is a very useful tool, it has many limitations. One limitation is that break-even analysis assumes that customers all pay the same price but, in reality, prices vary. This means that the break-even point calculated is likely to be inaccurate and, in fact, might be much higher. Using break-even analysis to set sales targets, to see how changes in costs may affect profit, and to evaluate company capacity are benefits of break-even analysis.

Key Term: the numerical difference between a firm’s volume of sales and its break-even quantity.

• Break Even Quantity

• Total Contribution

• Margin of Safety

• Target Profit

On a break-even chart, the total costs line slopes diagonally from left to right, beginning at the origin (zero).

• True

• False

Answer explanation

False - its starts at the value of fixed costs