Chapter 6

Risk Analysis

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 6.1. Origin/Sources of Project
• Risk is a condition where there is possibility of
deviation between desired & expected outcome but
for which an array of alternative outcomes & their
probabilities are known.
• The assignment of probabilities of various outcomes
of an investment project is generally called risk
analysis.

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Continue………..

Sources of risk
 Cash flow estimates
 Nature of business
 Rate of interest/rate of inflation
 Study period

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 Methods of Describing Risk
Break Even Analysis
• It is that output level which will be balance between total
cost & total revenue. In this situation producer will have
neither profit nor loss.
• Total cost of producing a good is the sum of fixed cost
and variable cost. So,
CT= CF + VC…………………. (i)
Where , CT = Total Cost
CF = Fixed Cost
VC = variable cost

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Continue………

• If ‘x’ is the quantity of production , & Vc

is the variable cost per unit output,
CT= CF + Vc *x………….. (ii)
• Total sales revenue (ST ) during same period will be ST = SP
*(X); where SP is the selling price/ unit
• So at Break Even Point (BEP);
• CT= ST
• CF + Vc *x = SP (X)
• CF = (SP - Vc )*(X)
• X= CF / (SP - Vc )…………. (iii)
• Which is the breakeven output volume denoted as XBEP or x’.

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 Break Even Analysis

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 Question No.: 1
A company produces an electronic timing switch that is
used in consumer and commercial products made by
several other manufacturing firms. The fixed cost and
total cost are Rs. 40,000 and Rs. 85,000 respectively.
The total sales are 1,05,000 and sales volume is
15,000. For this situation
i) Find breakeven points in-terms of number of units.
ii) What should be outputs if profit desired is Rs.
50,000?

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Solution
Given………………………………..
We know,
i) XBEP = CF / (SP - Vc )

=10,000 Units

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ii) Profit= Total sales -Total cost
Or, 50,000= SP *x- (CF+ Vc *x )
Or, 50,000=

Or, 50,000= 7(x)-[40,000+3(x)]

Or, 90,000=4(x)
.: x=22,500 units
Therefore, Breakeven unit for the profit to be Rs.
50,000 is 22,500 units.

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 Question No.: 2
A machine has a fixed cost of Rs. 40,00,000. It has
variable cost of Rs. 45,000 per unit. Find Breakeven
point both in volume and value if selling price per
unit is Rs. 60,000. What would be the effect on profit
/ loss when fixed cost increases by 10 % and selling
price decreases by 5%?

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• Given……
We know,
XBEP = CF / (SP - Vc )

=266.67 units
In-terms of value i.e sales,
ST = Sp(x)
= 60,000*266.67
= 1,60,00,200

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If fixed cost CF increases by 10% i.e
Fixed cost=40,00,000*1.1
= 44,00,000
Selling Price decreases by 5% i.e
Sp= 60,000*0.95
=57,000
Now,
Profit/loss = ST- CT
=Sp(x)-[CF + Vc (x)]
=57,000*266.67-[44,00,000+45,000*266.67]
= -11,99,960
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 Breakeven Analysis for Comparing
Two Alternatives
• Steps:
1. Define common variable and its dimensional units.
2. Use PW or AW analysis to express the total cost of each
alternatives as a function of common variable.
3. Equate the two relations and solve for the breakeven
value of the variable.
4. If anticipated level is below the breakeven value, select
alternative with higher variable cost (larger slope). If
the anticipated level is above the breakeven value select
the alternative with lower variable cost (smaller slope)

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 Breakeven Analysis for Comparing
Two Alternatives

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Question No.:3
Calculate the breakeven hours of operation per year to
become cost equal and recommend economic pump if
it is to be operated five hours daily at full load.
KHASA PUMP SARVO PUMP
Capacity 100Hp 100Hp
Purchase cost (Rs. ) 5,00,000 10,00,000
Tax per year (Rs.) 10,000 15,000
Maintenance cost per 36,500 29,200
year (Rs.)
Efficiency 80% 90%
Life year 5 5
Salvage value 20% of purchase
cost for both
MARR 20% per year
Electricity cost
09-Oct-20 Rs. 10/ Kwhr 15
Solution,
For KHASA PUMP
AW of purchase cost & salvage value
= 5,00,000 (A/P, 20%,5)-5,00,000*20% (A/F, 20%, 5)
= 5, 00, 000 * -1, 00, 000*

= 1,67,189.85 – 13,437.97
= 1,53,751.88

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 Contd………

• Maintenance cost / year = 36,500

• Tax/ year = 10,000
• Total fixed cost =1,53,751.88 + 36,500 + 10,000
=2,00,251.88
• Operating expenses for power ( electricity cost ),
• Operating expenses =input * rate * hours of operation
also,

so,

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 Contd………
• Operating expenses = * rate * hours
of operation
• Let ‘x’ be the number of hours of operation per
year,
• So, operating expenses = *10*X

=932.5(X)
Total cost =2,00,251.58+932.5 (X)……..(i)
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 Contd………
For SERVO PUMP
AW of purchase cost & salvage value
= 10,00,000 (A/P, 20%,5)-10,00,000*20%
(A/F, 20%, 5)
= 3,07,503.76
• Maintenance cost / year = 29,200
• Tax/ year = 15,000
• Total fixed cost = 3,51,703.76

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 Contd………
• Operating expenses = input * rate * hours of
operation
• Let ‘x’ be the number of hours of operation per
year,
• So, operating expenses = *10*X

=828.88(X)
Total cost =3,51,703.76+828.88 (X)……..(ii)
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 Contd………
• Equating (i) & (ii), at breakeven situation i=ii
or, 2,00,251.58+932.5(X)=3,51,703.76+828.88(X)
Or, X=1,461.06 ~ 1,462 hours
if it is to be operated 5 hrs. daily,
i.e. 5*365=1,825 hrs

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 Contd………
Costs in Lakhs
Khasa Pump

Servo Pump
5

1
Operating
Hours
0 1000 1,500 2,000 2500
09-Oct-20 500 22
 Contd………
• Since, operation hours per year (1,825) is
greater than breakeven point the alternative
with lower variable cost (smaller slope) is
selected i.e. SERVO Pump is selected.

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Question No.:4
CFL bulb of 20 watt costs Rs. 250 where as
filament bulb of 100 watt (20 watt CFL bulb is
equivalent to 100 watt filament bulb) costs
Rs.30. Which bulb do you prefer in your
house? Why? Electricity cost is Rs. 10 per unit.

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Solution
For CFL bulb:
1. Initial cost= Rs 250
2. Cost of use = Rs *10 *(X)
=0.2 (X)

Total cost =250 + 0.2 (X)………….(i)

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 Contd………
• For filament bulb :
1. Initial cost= Rs 30
2. Cost of use = Rs *10 *(X)
= (X)

Total cost =30 + (X)………….(ii)

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 Contd………
Equating eqn (i) & (ii) we get X= 275 hrs
• In a day we light bulb for approximately 4 hrs
Therefore, X= = 68.75~69 days
Since, I have to use for more than 69 days (275
hrs) which is more than breakeven point, I use
bulb having less slope i.e CFL bulb in my
house.

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 Thank You

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