Question

Estimating a cost function. The controller of the Javier Company is preparing the budget for 2018 and needs to estimate a cost function for delivery costs. Information regarding delivery costs incurred in the prior two months are:

Month	Miles Driven	Delivery Costs
August	11,600	$10,000
September	18,000	$13,200

Required:

1.   Estimate the cost function for delivery.

2.   Can the constant in the cost function be used as an estimate of fixed delivery cost per month? Explain.

Answer 1

1.

Variable cost per mile = Difference in cost/Difference in activity

= (13,200 - 10,000)/(18,000 - 11,600)

= 3,200/6,400

= $0.5

Fixed cost = Highest activity cost - (Highest activity x Variable cost per mile)

= 13,200 - (18,000 x 0.5)

= 13,200 - 9,000

= $4,200

Cost function for delivery

Total cost = Fixed cost + Number of miles x Variable cost per mile

= 4,200 + 0.5 x Number of miles

2.

Yes, the constant in the cost function can be used as an estimate of fixed delivery cost per month.

Here, $4,200 is the fixed delivery cost per month since it is independent of the number of miles driven.