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How to define time before break even

Anonymous A

Hi,

There are often cases when interviewer asks to determine the price of newly developed product. If R&D costs are significat, I always tend to do break even analysis and price always becomes to depend on time period, in which one wants new product ro break even. (I had case where I could freely choose price, varying break even time period between 3 and 20 years).

What are the criterias one should consider to decide the right time period for break even. Should I ask the interviewer when client wants to break even? What if I am asked about reasonable time period for break even.

Francesco replied on 06/19/2017
Ex BCG | MBB Specialist | #1 Expert for meetings done (900+) and recommendation rate (100%)

Hi Anonymous,

as you mentioned, there are two potential options for such a problem:

Option 1: you get the information from the interviewer, that is, either they provide the information at the beginning or you ask for that (which you are definitely allowed to do). You could receive the information as:

  • The relevant period of time directly (eg 5 years) or
  • The minimum return per year desired (eg 5%), which would allow you to compute such period of time (if you have to reach €5M back investing €5M, and the desired minimum return per year is 5%, then you would reach the target in maximum 20 years with simple interest and no discount factor, as given solving the following formula: 5M*0,05*x=5M).

Option 2: you have to estimate the right period of time. In this case, the best option is to consider which is the opportunity cost for the company if it would have to invest the money in a comparable risky option; usually, this information is provided as expected return of the alternatives. You can then use such an interest rate as before to compute the maximum period to reach the target.

As an example, if your goal is still to reach €5M back with an investment of €5M, and you know the minimum return for an equivalent risky option is 10%, then you know you would have to reach you goal in maximum 10 years, using the same math formula as before. If the alternative is less risky, you would then have to reach it in less then 10 years, to compensate for the higher risk, while if it is more risky, you could reach it in more then 10 years for the same reason, unless there are additional constraints in the case.

Hope this helps,

Francesco

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