confusing a competitor chapter 16 Ralph has invented and patented a new eonsumer recording device. The projected manufaeturing eost is low, and Ralph is worried that once this faet beeomes known, many eompetitors will enter the market, using marginaIly different product designs that cireumvent the patent. A eousin suggests merging with an unrelated business. That way, the eousin explains, even with line-of-business reporting a weIl-chosen eost aIloeation scheme will obfuscate the low produetion eost. Ralph is not particulady pleased with this idea but also aeknowledges that disclosure laws ean be disadvantageous. (Ralph is also aware that a private finn is not subject to these disclosure requirements.)

To explore this further, Ralph puts together a sample of 9 data points from two hypothetical finns. The new reeording device has a eost curve of costl = 150,000

+ lOql + El' where ql denotes units of produetion and El is a random error term. The target finn has a eost structure of eost2 = 450,000 + 90~ + E2 (where ~ denotes units of production and E2 is another random error term). The data are listed below. You should assume no finished goods inventories are present, so production and sales are perfectly aligned.

t ql 'h eostl eos~

1 17,241 4,882 305,762 882,462 2 1,825 3,095 152,786 717,372 3 8,357 8,747 262,312 1,228,470 4 13,078 8,805 263,136 1,237,098 5 10,272 1,297 249,436 571,502 6 11,729 1,115 282,526 523,300 7 19,097 6,490 342,652 1,036,410 8 19,754 183 343,678 428,554 9 1,819 1,970 164,352 629,828 aJ Regress eostl on ql. Does this suggest Ralph's eompetitors will have an easy time identifying the eost curve?

b J Suppose the two hypothetical firms are merged. Total eost, eonsisting of eostl

+ eos~, is allocated to the two product lines on the basis of physical units. What happens when you regress eost aIlocated to the first product on units of that product?

Does this suggest Ralph' s competitors will have a difficuU time identifying the eost curve if the merger is eonsummated and the accountant's art is fuIly engaged?

e] What mistake is Ralph making? (Hint: using, say, the alloeated data in [b]
regress total eost on ql and <12.).

AppendixLO1