I agree with some aspects and disagree with others. Firstly, I disagree with the definition of break-even analysis. The post defines break even as the point at which the firm is able to cover the cost of purchasing a new equipment. On the contrary, break-even point is the point at which the firm is able to cover all fixed expenses with regard to a new project. Depreciation maybe included and not the entire cost of the equipment. This is because the cost is amortized over the useful life of the project. Accounting for the entire equipment cost in one year is wrong because it creates the notion that the equipment is only useful for one year which may not be the case. However, I agree that break even analysis does not factor in the cost of capital which is used to finance the project. Therefore, it ignores a crucial element in evaluating investment decisions.
I agree with post that break-even analysis is essential but it is only useful if it used together with other investment valuation techniques. The alternative investment techniques such as sensitivity analysis and decision tree are able to cover for the shortcomings of break-even analysis. Break even analysis is based on the accrual accounting system which can easily be manipulated by managers to meet certain selfish needs. Besides, break even analysis assumes the various parameters such as selling price, variable costs and fixed costs are known in advance. However, in real life there is uncertainty. It is difficult to accurately predict certain elements such as selling price. Market price often fluctuates depending on market demand, supply, economic conditions, and government regulations among many other factors. Therefore, methods that incorporate uncertainty and risk should also be used.
References
Khan, W. (2004). Financial Management: Text, Problems And Cases. New York: Tata McGraw-Hill Education.
Shim, J., & Siegel, J. (2008). Financial Management (New ed.). New York: Barron's Educational Series.
