Regression Line of Overhead Costs on Labor-Hours for Linda Olson’s Character Business

10-32 High-low, regression. Mandy Knox is the new manager of the materials storeroom for
Timken Manufacturing. Mandy has been asked to estimate future monthly purchase costs for part
#696, used in two of Timken’s products. Mandy has purchase cost and quantity data for the past
9 months as follows:

Month Cost of Purchase Quantity Purchased

January $12,468 2,700 parts
February 12,660 2,820
March 17,280 4,068
April 15,816 3,744
May 13,164 2,988
June 13,896 3,216
July 15,228 3,636
August 10,272 2,316
Septembe 14,940 3,552
r

Estimated monthly purchases for this part based on expected demand of the two products for the
rest of the year are as follows:

Month Purchase Quantity Expected

October 3,360 parts
Novembe 3,720
r
December 3,000
 Required:
1. The computer in Mandy’s office is down, and Mandy has been asked to immediately provide an
equation to estimate the future purchase cost for part #696. Mandy grabs a calculator and uses
the highlow method to estimate a cost equation. What equation does she get? 
2. Using the equation from requirement 1, calculate the future expected purchase costs for each of
the last 3 months of the year. 
3. After a few hours Mandy’s computer is fixed. Mandy uses the first 9 months of data and
regression analysis to estimate the relationship between the quantity purchased and purchase
costs of part #696. The regression line Mandy obtains is as follows: 
y = $2,135.5 + 3.67X
Evaluate the regression line using the criteria of economic plausibility, goodness of fit, and
significance of the independent variable. Compare the regression equation to the equation
based on the high-low method. Which is a better fit? Why? 
4. Use the regression results to calculate the expected purchase costs for October, November, and
December. Compare the expected purchase costs to the expected purchase costs calculated using
the high-low method in requirement 2. Comment on your results.

SOLUTION

(25 min.)   High-low, regression

1. Mandy will pick the highest point of activity, 4,068 parts (March) at $17,280 of cost, and
the lowest point of activity, 2,316 parts (August) at $10,272. 

Cost driver:
Quantity Purchased Cost
Highest observation of cost 4,068 $17,280
driver
Lowest observation of cost driver 2,316   10,272
Difference 1,752 $  7,008

Purchase costs = a + b Quantity purchased

Slope Coefficient = $7,008/1,752 = $4 per part
Constant (a) = $17,280 ─ ($4 4,068) = $1,008
The equation Mandy gets is:
Purchase costs = $1,008 + ($4 Quantity purchased)

2. Using the equation above, the expected purchase costs for each month will be:

Mont Purchase Quantity  Expected 

h Expected Formula cost
October 3,360 parts y = $1,008+ ($4 3,360) $14,448
November 3,720 y = $1,008 + ($4 3,720) 15,888
December 3,000 y = $1,008 + ($4 3,000) 13,008
3. Economic Plausibility:  Clearly, the cost of purchasing a part is associated with the quantity
purchased.
Goodness of Fit:  As seen in Solution Exhibit 10-32, the regression line fits the data well.
The vertical distance between the regression line and observations is small. An r-squared value
of greater than 0.98 indicates that more than 98 percent of the change in cost can be explained by
the change in quantity.
Significance of the Independent Variable:  The relatively steep slope of the regression
line suggests that the quantity purchased is correlated with purchasing cost for part #696.

SOLUTION EXHIBIT 10-32