Question

Describe how to maximize the value of each purchase by utilizing a break-even analysis to make rational decisions about corporate spending, financing projects, or making investments. Would you consider cost-benefit analysis as a practical way of assessing the usefulness of projects, in both public and private companies? Why or why not?

Please include references.

Answer 1

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Break-even analysis is a way by which marketers can determine the lowest price at which a product can be sold. If the product is sold at anything lower than the break-even price, the company makes a loss. This is not something that any company can continue to do except for a very short period of time. Break-even analysis is a business tool widely used across all industries to evaluate business performance in terms of costs, since this is a supply-side analysis. Break-even analysis is an important aspect of a good business plan, since it helps the business determine the cost structures, and the number of units that need to be sold in order to cover the cost or make a profit. Break-even analysis is usually done as part of a business plan to see the how practical the business idea is, and whether or not it is worth pursuing. Even after a business has been set-up, break-even analysis can be immensely helpful in the pricing and promotion process, along with cost control.

While taking business decisions the private firms or public firms being driven mainly by profit motive take into account only the internal direct effects (that is, cash flows accruing to them and the costs they have to incur) and do not take the longer and wider view of their activities from the social point of view. But public enterprises and non-profit institutions have to take a broader social repercussion of their resource allocation and investment decisions. That is, they take into account both internal (direct) and external (indirect) effects of their business decisions.

An analytical model called cost-benefit analysis is used to analyse the wider impact of resource allocation and investment decisions. Properly understood, it is Social Cost-Benefit Analysis of investment projects though the word’ social’ is often omitted. Thus in social cost-benefit analysis, we estimate both the direct and indirect costs of a project to the society and both the direct and indirect benefits to it. These indirect costs and indirect benefits are often called externalities. Thus social cost and benefit analysis in addition to the direct costs and benefits take into account the externalities of an investment project.

References:

Saywell Jr, R. M., Cordell, W. H., Nyhuis, A. W., Giles, B. K., Culler, S. D., Woods, J. R., ... & Rodman Jr, G. H. (1995). The use of a break‐even analysis: financial analysis of a fast‐track program. Academic emergency medicine, 2(8), 739-745.

Levy, H., & Brooks, R. (1986). Financial break-even analysis and the value of the firm. Financial Management, 22-26.

Layard, P. R. G. (1994). Cost-benefit analysis. Cambridge University Press.

Boardman, A. E., Greenberg, D. H., Vining, A. R., & Weimer, D. L. (2017). Cost-benefit analysis: concepts and practice. Cambridge University Press.