1 73% .. Metro by T-Mobile LTE 8:23 PM Constructing a Breakeven Chart The following steps outline the procedure for constructing a graph that visually por- trays a company's breakeven point (that point where revenues equal expenses): Step 1. On the horizontal axis, mark a scale measuring sales volume in dollars (or in units sold or some other measure of volume). The breakeven chart for the Magic Shop shown in Figure 12.60 uses sales volume in dollars because it applies to all types of businesses, departments, and products, Figure 12.6 Breakeven Chart for the Magic Shop Step 2. On the vertical axis, mark a scale measuring income and expenses in dollars. Step 3. Draw a fixed expense line intersect- ing the vertical axis at the proper dol- lar level parallel to the horizontal axis. The area between this line and the horizontal axis represents the company's fixed expenses. On the breakeven chart for the Magic Shop .. Metro by T-Mobile LTE 8:23 PM 1 73% Step 2. On the vertical axis, mark a scale measuring income and expenses in dollars. Step 3. Draw a fixed expense line intersect- ing the vertical axis at the proper dol- lar level parallel to the horizontal axis. The area between this line and the horizontal axis represents the company's fixed expenses. On the breakeven chart for the Magic Shop shown in Figure 12.60, the fixed ex- pense line is drawn horizontally be- ginning at $177,375 (point A). Be- cause this line is parallel to the hori- zontal axis, it indicates that fixed ex- penses remain constant at all levels of activity. Step 4. Draw a total expense line that slopes upward beginning at the point where the fixed cost line intersects the verti- cal axis. The precise location of the total expense line is determined by plotting the total cost incurred at a particular sales volume. The total cost for a given sales level is found by using the following formula: Total expenses Fixed expenses + Variable expenses expressed as a % of sales Sales level Arbitrarily choosing a sales level of $950,000, the Magic Shop's total costs would be as follows: Total expenses = $177,375 +0.74 x 950,000) - $880,375 Thus, the Magic Shop's total cost is $880,375 at a net sales level of $950,000 (point B). The variable cost .. Metro by T-Mobile LTE 8:23 PM 10 73% Thus, the Magic Shop's total cost is $880,375 at a net sales level of $950,000 (point B). The variable cost line is drawn by connecting points A and B. The area between the total cost line and the horizontal axis measures the total costs the Magic Shop incurs at various levels of sales. For example, if the Magic Shop's sales are $850,000, its total costs will be $806,375. Step 5. Beginning at the graph's origin, draw a 45-degree revenue line showing where total sales volume equals total income. For the Magic Shop, point shows that sales - income - $950,000. Step 6. Locate the breakeven point by finding the intersection of the total expense line and the revenue line. If the Magic Shop operates at a sales volume to the left of the breakeven point, it will incur a loss because the expense line is higher than the revenue line over this range. This is shown by the triangular section labeled "Loss Area." On the other hand, if the firm operates at a sales volume to the right of the breakeven point, it will earn a profit because the revenue line lies above the expense line over this range. This is shown by the tri- angular section labeled "Profit Area. You Be the Consultant ..ll Metro by T-Mobile . 7:34 PM @70 45% 4 You Be the Consultant Where Do We Break Even? Anita Dawson is doing some finan- cial planning for her small gift store. According to her budget for the up- coming year, Anita is expecting sales of S495.000. She estimates that the cost of goods sold will be $337,000, and other variable expenses will to- tal $42,750. Using the previous year as a guide, Anita anticipates fixed expenses of $78,100. Anita recalls a meeting she had re- cently with her accountant, who mentioned that her store already had passed its breakeven point eight and a half months into the year. She was pleased but really didn't know how the accountant had come up with that calculation. Now Anita is con- sidering expanding her store into a vacant building next door to her ex- isting location and taking on three new product lines. The company's cost structure would change, adding another $66,000 to fixed costs and $22.400 to variable expenses. Anita believes the expansion could gener- ate additional sales of $102.000 in the first year. She wonders what she should do. 1. Calculate Anita's breakeven point without the expansion plans. Draw a breakeven chart. 10 45% ..ll Metro by T-Mobile 7:34 PM { a Q W AA Anita recalls a meeting she had re- cently with her accountant, who mentioned that her store already had passed its breakeven point eight and a half months into the year. She was pleased but really didn't know how the accountant had come up with that calculation. Now Anita is con- sidering expanding her store into a vacant building next door to her ex- isting location and taking on three new product lines. The company's cost structure would change, adding another 566,000 to fixed costs and $22.400 to variable expenses. Anita believes the expansion could gener- ate additional sales of $102,000 in the first year. She wonders what she should do 1. Calculate Anita's breakeven point without the expansion plans. Draw a breakeven chart. 2. Compute the breakeven point. assuming that Anita decides to expand her business. 3. Do you recommend that Anita expand her business? Explain.