On episode 109 of the Tutors of Life podcast, Sam and I broke down how to calculate break even. Essentially, break even is, when the thing you want to purchase, will pay off. This is a great technique to use in personal life and in business life. It has helped me buy a lot of stuff and has helped me pass on a lot of stuff. I wanted to give a more in depth breakdown in a blog for people to see and understand.
Right now I drive a diesel truck for work. I haul trailers every week, so I need something bigger than a 1/2 ton pickup. The 1 ton diesel I bought was in my price range, so I purchased it. However, I only tow trailers and do extensive material runs where I need a big truck, 1/4 of my drive time. About 1/2 of my driving is running errands, small material runs, appointments, etc. The last 1/4 of my driving is personal. I drive roughly 2000 miles a month. So, the question is, would it be worth me getting a car to drive around, the other 1500 miles I do not need to haul things? Lets break it down:
Lets say I want to purchase a $10,000 car that gets 30mpg. How long will it take for me to break even on this purchase, not including depreciation, insurance, or resale?
- Current MPG – 13mpg diesel @$5 a gallon
- Truck costs $5/13=$.384 per gallon to drive
- Total monthly cost 1500x.384=$577
- New car mpg – 30mpg @ $4 a gallon
- Car costs $4/30=$.133 per gallon to drive
- Total monthly cost 1500x.133=$200
- Difference in gas $577-$200=$377
- $10,000/$377=26.5 months
- Our break even is 26.5 months to purchase the car.
- This does not include insurance, registration, or maintenance.
- On the contrary, it does not include depreciation(if business owned) or resale price.
Depending on your situation, a 2.5 year break even seems like a pretty good deal to me. Main things that could play a role to make this number bigger or smaller, would be gas prices, prices of cars, or if I drive less or more.
I will give one more example of how I do this with rentals. Say I am looking at doing a unit turnover. A unit turnover will involve new appliances, flooring, light fixtures, and paint. This turnaround is going to cost $12,000. My current rent as it sits is $750 but if I do the rehab, it will be $1,000. So, lets calculate how long it will take to make my money back on this rehab, if its worth it or if we should not update.
- $12000/$250=48 months
- 48 months is 4 years or a 25% cash on cash return.
- Most people shoot for a 8-12% return in the stock market (which is their cash in the market)
- So, a 25% return is over double the high side of what people shoot for in the market.
- This 25% return is most certainly worth doing the rehab for the increased rents (I am actually in the progress of doing this on one of my properties, but its actually $600 a month to $1000)
This is how I calculate if something is worth doing or not. I did this calculation on one of my units in Bloomer WI. The increased rent compared to my unit turnover I would like to do, was a 10% return (or in other words, a 10 year pay back). I could not justify a 10 year pay back, so we did a minor turn and an increase in rent to put me around 18% cash on cash return. I tend to shoot for a 20% cash on cash return, so I was okay with doing that.
Try calculating some of the things you want or need in life to see what their break even is. It may make you pass on some stuff you thought you wanted.
Your life Tutor