Central Machinery Ltd. is preparing its budget for the year ending 30 June 2004. For the fuel expenses consumption it is decided to estimate an equation of the form, y = a + bx, where y is the total expense at an activity level x, a is the fixed expense and b is the rate of variable cost.
The following information relate to the year ended 30 June 2003:
|
Month
|
Machine hours
|
Fuel Oil expense
|
Month
|
Machine hours
|
Fuel oil expense
|
|
2003
|
(Sh. '000')
|
(Sh. '000')
|
2004
|
(Sh. '000')
|
(Sh. '000')
|
|
July
August
September
October
November
December
|
34
30
34
39
42
32
|
640
620
620
590
500
530
|
January
February
March
April
May
June
|
26
26
31
35
43
48
|
500
500
530
550
580
680
|
The annual total and monthly average figures for the year ended 30 June 2003 were as follows:
|
Machine hours
|
Fuel oil expense
|
|
('000')
|
(Sh. '000')
|
|
Annual total
Monthly average
|
420
35
|
6,840
570
|
Required:
(i) Using the high-low method, estimate and interpret the fixed and variable cost elements of the fuel oil expense.
(ii) Using the results in (i) above, predict the fuel oil expense for November 2004 if experience indicates that 41,000 machine hours will be used.
(iii) Briefly explain any two limitations of High-low method of cost estimation that may be overcome by using simple linear regression analysis.
(iv) By using simple linear regression analysis it is established that the co-efficient of determination arising from the data is approximately 0.25. Interpret the significance of this fact.