Question

James House is planning on starting a cleaning services business but has not decided whether he should focus on residential clients or commercial clients. His estimates of revenue, variable expenses, and fixed expenses are shown below.

 

	Residential	Commercial
Revenue	$25 per hour	$35 per hour
Variable expense	$15 per hour	$20 per hour
Fixed expense	$500 per month	$825 per hour

 

Required:

1. At what volume of hours per month will James be indifferent between focusing on residential versus commercial clients?

2. Calculate the number of break-even hours for residential clients and commercial clients.

Answer 1

1.

The indifference point in hours can be calculated using the following formula:

(Residential CM per hour x Q) - $500 = (Commercial CM per hour) - $750

Where Q = the number of hours.

 

($25-$15)Q - $500 = ($35-$20)Q - $825

10Q - $500 = $15Q - 825

Q = 65 hours

 

James will be indifferent between choosing to focus on residential versus commercial clients at a volume of 65 hours per month.

 

2.

Break-even hours for residential clients:

Fixed expenses / CM per unit = $500/$10 = 50 hours

  

Break-even hours for commercial clients:

 

Fixed expenses / CM per unit = $825 / $15 = 55 hours

James will be indifferent between choosing to focus on residential versus commercial clients at a volume of 65 hours per month.

 

Break-even hours for residential clients: 50 hours

Break-even hours for commercial clients: 55 hours