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The Cost Function

# The Cost Function - Chapter 2 The Cost Function SOLUTIONS...

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Chapter 2 The Cost Function SOLUTIONS Eldenburg & Wolcott 2e August 2010 LEARNING OBJECTIVES Chapter 2 addresses the following questions: Q1 What are different ways to describe cost behavior? Q2 What process is used to estimate future costs? Q3 How are the engineered estimate, account analysis, and two-point methods used to estimate cost functions? Q4 How does a scatter plot assist with categorizing a cost? Q5 How is regression analysis used to estimate a mixed cost function? Q6 How are cost estimates used in decision making? These learning questions (Q1 through Q6) are cross-referenced in the textbook to individual exercises and problems. COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems.

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2-2 Cost Management QUESTIONS 2.1 Fixed costs do not vary with small changes in activity levels. Fixed costs within a car rental agency include the salaries of managers, rent, lease, or depreciation on the building located on the rental lot, and advertising costs, among others. 2.2 Variable costs change proportionately with changes in activity levels. Variable costs in a car rental agency include the cost to wash each car, inspection costs after each rental, and the cost of maps and supplies for the paperwork for each rental, among others. 2.3 Mixed costs are partly fixed and partly variable. Examples of mixed costs in a car rental agency include the cost of wages if some part time workers have a regular schedule and others are called in during busy times. Another cost could be water used in washing the cars. Many water companies charge a flat fee for a minimum amount of water and then apply a charge that varies proportionately with the amount of water used. 2.4 Outliers do not reflect normal operations and are much higher or lower than the other observations. Because they lie outside the range of normal operations, they may bias the results of analysis when developing a cost function, resulting in estimates of cost that are either too high or too low. 2.5 This function has both fixed costs and variable costs. If at least part of the cost is variable; total cost increases as production volumes increase. If at least part of the cost is fixed, the average total per-unit cost decreases because the average fixed cost decreases as volume increases. 2.6 Several years’ worth of data for August would be helpful for estimating the overhead cost function for subsequent Augusts, but the August data should not be used for estimating the overhead cost function for other months during the year. It is highly unlikely that the August data would reflect the data during normal operations. However, August’s costs are probably a good estimate of the fixed costs for other months. When zero production occurs, only fixed costs are incurred.
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