The controller of the Connecticut Electronics Company believes that identification of the variable and fixed components of the firm’s costs will enable the firm to make better planning and control decisions. Among the costs the controller is concerned about is the behavior of indirect supplies expense. He believes there is some correlation between the machine-hours worked and the amount of indirect supplies used.

A member of the controller’s staff has suggested that a simple linear regression model be used to determine the cost behavior of the indirect supplies. The following regression equation was developed from 40 pairs of observations using the least squares method of regression.

The regression equation and related measures are as follows:

Required:

a. When a simple linear regression model is used to make inferences about a population relationship from sample data, what assumptions must be made before the inferences can be accepted as valid?

b. Assume the assumptions identified in Requirement a are satisfied for the indirect supplies expense of Connecticut Electronics Company.
(1) Explain the meaning of 200 and 4 in the regression equation S = $200 + $4H.
(2) Calculate the estimated cost of indirect supplies if 900 machine-hours are to be used during a month.

c. Explain briefly what the (1) Coefficient of correlation measures.
(2) Value of the coefficient of correlation (r = .87) indicates if Connecticut Electronics Company wishes to predict the total cost of indirect supplies on the basis of estimated machine-hours.

Transcribed Image Text:

where S H = = S = $200 = $4H Total monthly costs of indirect supplies Machine-hours per month Standard error of estimate: S, = 100 Coefficient of correlation: r = .87