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	$	125	per hour	$	135	per hour
Variable expense	$	75	per hour	$	54	per hour
Fixed expense	$	20,250	per month	$	25,272	per month

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. (Round your answers to 1 decimal place.)

3. Assume that James decides to focus on commercial clients and his business is operating at 370 hours per month. Calculate the margin of safety both in dollars and as a percentage of sales. (Round percentage answer to 1 decimal place.)

Answer 1

Answer:

1) Cost Indifference Point = Differential fixed cost/Differential variable cost per unit = $25272-20250 / $75-54

= 239.14 =239 hours

2) Breakeven hours = Fixed cost / contribution margin per unit

Residential clients = $20250 / $125-75 = 405 hours

Commercial clients = $25272/ $135-54 = 312 hours

3) Margin of safety

Formula as % of sales = Current level of sales - Breakeven sales / Current level sales

= 370 - 312/370 = 15.7 %

margin of safety in dollar = (370 hours - 312 hours )*135 = $7,830