Question

The following is six months of data on the cost and production volume to manufacture crates of skittles. In order to better predict costs, the manager is trying to understand the relationship between production volume and cost. Use the hi-lo method to determine the cost equation. Round as needed to the closest penny.  (Please report the cost equation in y=mx+b format).

	Production Volume	Total Cost
July	265	$4,920
August	320	$5,210
September	745	$8,760
October	410	$6,020
November	530	$7,300
December	740	$12,900

Answer 1

High low method assumes that linear model of cost behaviour is valid. Hence, the following equation can be used to compute variable and fixed costs.

y = a + bx

where:

y = total cost;

a = total fixed costs;

b = variable cost per level of activity (or units);

x = level of activity (or number of units).

Step 1

Determine the lowest point of activity (x1) and the corresponding cost (y1), and the highest point of activity (x2) and its corresponding cost (y2)

Highest point of activity (x1) = September = 745

Corresponding cost at highest point (y1) = September = $8,760

Lowest point of activity (x2) = July = 265

Corresponding cost at lowest point (y2) = July = $4.920

Step 2

Compute for the variable cost per unit or slope (b) using the formula:

b =	y2 - y1
	x2 - x1

b= $8,760 – $4,920

      $745 – 265

b= 8 per unit

Step 3

Determine the fixed cost (a) by substituting the slope in the cost equation

Y = a + bx

Adding the value from highest point September

8,760 = a + 8 X 745

a = 8,760 – 5,960

a = 2,800

Step 4

Now that we have isolated both the fixed and the variable components, we can express total cost in the following equation:

Y = $2,800 + 8x

Where Y is total cost and x is production volume.