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What Is Break-Even Price?

Break-Even Price Definition

The breakeven price is the amount of money an investor must sell to regain the costs of buying and owning the asset. In other words, it could also be indicating the amount of money required to cover the costs of producing or providing a good or service.

Anything that you buy has a price, and when you eventually sell it, you will either leave with more or less money than before. Whether you make a profit, therefore, depends on how much money you have left.

Breakeven prices are vital as they allow consumers and investors to manage their risks, raising awareness about when they will make losses and lose out on profits.

Learning what breakeven prices are, why they are important and how you could use them in your trading strategies will allow you to become an even better investor.

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Break-Even Price Explained with Examples

The breakeven price is significant for any investor or firm because it is the price that they need to cover all of their total costs [1].

The breakeven price, also known as a break-even or often abbreviated as B/E in finance, indicates that the total revenue from an asset is equal to its total costs. In economics, people pretend as if this is the most logical thing in the world. Why? Because it is human [2].

Imagine that you run a pizzeria, and it costs you €5 to make a pizza. This cost includes all economic costs. In the case of the pizzeria, think about these costs to include the cost of the dough, the toppings, the prices of turning and keeping on the oven, and the labour costs.

When you eventually start selling the pizza, at what price would you at least want to sell that pizza? That is right - you may want to sell that pizza for €5 as well.

Suppose that you want to sell this pizza for a lower price, for instance, €4. In that case, you may end up with €4 in money coming in - but you have initially already exerted €5. You are left with less money than before, and you have just made a loss of €1.

It may be pretty easy when we simply look at a pizzeria.

What if it is a multinational corporation, like Apple? In that case, it becomes challenging to figure out the best costs and prices for the firm.

Nevertheless, figuring out the total costs for producing, say, an Apple iPhone would be the first step towards finding out the breakeven price. Creating an Apple iPhone would include expenses such as the resource and material costs, the labour costs, maintaining the production site, etc.

However, despite all of these different cost forms, the eventual breakeven price for which Apple should sell the iPhone exactly equals the initial costs of producing the iPhone.

The same principle applies to anything that you may want to buy. Suppose that you want to buy a stock for $50 per share. Assuming that there are no commission costs and other transaction costs, your total expenses would equal $50. If you sell the stock for $60, you would have made a $10 profit. If you sell the stock for $40, you have lost $10.

However, if you eventually sell the stock at $50, you would not have made any profits, nor have you made any losses. That is the point where you break even - the breakeven point (BEP).

Last example to make it stick - say that you want to buy a home and eventually, after a couple of years, you want to sell the house again for, hopefully, a reasonable price.

Things may be a little trickier when it comes to real estate because there are other costs in play that are important to consider. After all, buying a house includes a house price in itself and any insurance costs, interest payments, taxes, commissions, etc., that will have to be considered.

When you want to sell your house at some point, you would like to know that the price for which you are selling the home will equal the breakeven price - where you will not be losing any money.

How Break-Even Price Works

The principle of break-even prices is straightforward. However, from the examples above, we can see that this may not always be the case. Sometimes, the costs may be challenging to be determined - and similarly, the prices could also be hard to find.

That is why break-even prices can be determined mathematically.

When you are buying something - money is flowing out of your wallet, net worth, etc. When you sell what you have bought earlier, money will be flowing into your wallet, net worth, etc.

From a simplistic perspective, break-even prices work by 1) adding all costs of producing a good, delivering a service or purchasing an asset and 2) comparing with the eventual revenue gained from this decision. Both should then be equal to each other to determine the break-even price.

Whereas the production costs, in this case, may include both fixed fees and variable costs, the break-even price would consist of both cost types in the calculation [3]. As such, the general calculation for break-even prices can be shown as [4]:

BEP = (Fc/V) + Cv, Where

BEP = Break Even price

Fc = Fixed Cost

V = Unit Volume

Cv = Variable Cost per Unit

Take the following example to understand the calculation better. The standard of using break-even prices in producing a dress shirt considers this calculation as well.

Suppose that Firm ‘Shirtmania’ makes dress shirts for wild and adventurous people. They would like to introduce a new type of dress shirt that is easy to wear and maintain, named ‘Shirt Vibes’. The following costs for producing this shirt have been calculated:

  • Material costs: $20

  • Labour costs: $25

  • Manufacturing costs: $10

  • Cost per shirt: $10 + $25 + $20 = $55

  • Total fixed costs: $500,000

Suppose that Shirtmania wants to produce 50,000 shirts. The break-even sales price should then be:

Breakeven sales price = ($500,000/ 50,000) + $55 = $10 + $55 = $65

Now, suppose that Shirtmania wants to produce 75,000 shirts. The break-even sales price would then change to:

Breakeven sales price = ($500,000/ 75,000) + $55 = $61.67

One more example to make it clear. Suppose that Shirtmania wants to produce 100,000 shirts. The break-even sales price would then change to:

Breakeven sales price = ($500,000/ 100,000) + $55 = $60

You could note that the more products Shirtmania produces (i.e., the volume increases), the lower the break-even sales price becomes. That can be explained because the fixed costs are distributed over a higher amount of products, while the variable costs to produce the products remains equal.

Break-Even Prices & Options

Break-even prices also exist in options trading - after all, investors purchase the options contracts for a specific price [5]. This is also called the premium price.

When investors are buying an options contract, they are expecting that the price will move in a certain direction and that after expiry of the contract, the investor is provided with the opportunity to purchase a specific amount of that asset for an agreed amount - the strike price.

He or she in this case can expect the price to increase and buy a call option, or buy a put option when they expect the price to fall (assuming the simplified scenario; note that investors can also sell call or put options).

If you want to buy the call option, and you expect that the price will increase, you may want to make sure that your breakeven price is calculated already. Suppose that you want to buy an option contract giving you the right to buy 100 shares of Stock XKL (not a real ticker, by the way) that costs $50 per share.

The option contract costs $1 per share including a commission of say $10. Your total cost would then be:

Option cost = (option price x volume) + commission

= $1 x 100 shares + $10