Unformatted text preview: estimated cost function to determine if the cost function provides a good estimation. Diff: 2 Terms: cost estimation Objective: 4 AACSB: Reflective thinking 178) What are the three criteria a company should use to evaluate and choose a cost driver? Briefly explain each of the three criteria. Answer: The three criteria a company should use to evaluate a cost driver are economic plausibility, goodness of fit, and significance of the independent variable. Economic plausibility involves the theoretical existence of a causal relationship between a driver and the costs it is supposed to drive. Goodness of fit involves the observed differences between predictions of costs based on the cost driver and the actual costs that occurred. Significance of the independent variable involves the steepness of the slope of the cost driver relative to the slope of other possible cost drivers. The steeper the slope (given the same goodness of fit) the stronger is the relationship between the cost driver and the related costs. Diff: 2 Terms: cost function, cost estimation Objective: 5 AACSB: Reflective thinking 179) Discuss the potential use of nonlinear curves in cost functions and cost analysis. Give some examples. Answer: Cost functions are not always linear. A nonlinear cost function is a cost function for which the graph of total costs is not a straight line within the relevant range of operations. One example is a series of straight line segments that change their slopes at critical intersection points within the range of operation. Another example would be a step function. A step function is a function where the cost remains the same over various ranges of the level of activity, but the cost increases by discrete amounts (or steps) as the level of activity advances from one range to another. In addition to the examples mentioned above, there are situations wh...
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 Spring '08
 BROWN
 AACSB, Reflective thinking

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