Chapter 6, Problem 52C

Refer to the data and accompanying information in the preceding case.

Required:

1. Use the high-low method to estimate the cost behavior for the clinic’s administrative costs. Express the cost behavior in formula form (Y = a + bX). What is the variable cost per patient?

2. Build a spreadsheet: Construct an Excel spreadsheet and use the Excel commands to perform a least-squares regression and estimate the administrative cost behavior. Express the cost behavior in formula form. What is the variable cost per patient? Compute and interpret the R² value for the regression.

3. Write a memo to the hospital administrator comparing the cost estimates using (a) least-squares regression, (b) the high-low method, and (c) the scatter diagram and visually fit semivariable-cost line from the preceding case (requirement (4). Make a recommendation as to which estimate should be used, and support your recommendation. Make any other suggestions you feel are appropriate.

4. After receiving the memo comparing the three cost estimates, Mahoney called McDonough to discuss the matter. The following exchange occurred.

Mahoney: “As you know, Megan, I was never in favor of this clinic. It’s going to be a drag on our administrative staff, and we’d have been far better off keeping the pediatrics operation here in the hospital.”

McDonough: “I was aware that you felt the clinic was a mistake. Of course, the board of trustees had other issues to consider. I believe the board felt the clinic should be built to make pediatric care more accessible to the economically depressed area on the other side of the city.”

Mahoney: “That’s true, but the board doesn’t realize how difficult it’s going to make life for us here in the hospital. In any case, I called to tell you that when you and I report to the board next week, I’m going to recommend that the clinic be shut down. I want you to support my recommendation with one of your cost estimates showing that administrative costs will soar at high activity levels.”

McDonough: “But that estimate was based on the high-low method. It’s not an appropriate method for this situation.”

Mahoney: “It is an estimate, Megan, and it’s based on a well-known estimation method. This is just the ammunition I need to make the board see things my way.”

McDonough: “I don’t know, Jeff. I just don’t think I can go along with that.”

Mahoney: “Be a team player, Megan. I’ve got a meeting now. Got to run.”

That night McDonough called to discuss the matter with her best friend, you. What would you advise her?