Scattergraph, High-Low Method, Method of Least Squares, Use of Judgment

The management of Wheeler Company has decided to develop cost formulas for its major overhead activities. Wheeler uses a highly automated manufacturing process, and power costs are a significant manufacturing cost. Cost analysts have decided that power costs are mixed. The costs must be broken into their fixed and variable elements so that the cost behavior of the power usage activity can be properly described. Machine hours have been selected as the activity driver for power costs. The following data for the past eight quarters have been collected:

Quarter		Machine Hours			Power Cost
1		20,000			$26,000
2		25,000			38,000
3		30,000			42,500
4		22,000			37,000
5		21,000			34,000
6		18,000			29,000
7		24,000			36,000
8		28,000			40,000

Required:

1. Prepare a scattergraph by plotting power costs against machine hours. Does the scattergraph show a linear relationship between machine hours and power cost? Yes

2. Using the high and low points (i.e., the high-low method), compute a power cost formula. (Note: Round variable rate to three decimal places.)

Total power cost = $ + ( $ x Number of machine hours )

3. Use the method of least squares to compute a power cost formula. Evaluate the coefficient of determination.

Variable rate (to two decimal places)	$	per machine hour
Fixed cost (to the nearest dollar)	$
Coefficient of determination (R2) (to one decimal place).		%

4. Conceptual Connection: Rerun the regression, and drop the point (20,000, $26,000) as an outlier. Compare the results from this regression to those for the regression in Requirement 3. Which is better?