MBA 612, Spring 2011

Assignment 1.

Problem 1. Fixed and Variable Costs

The university athletic department has been asked to host a professional basketball game at
the campus sports center. The athletic director must estimate the cost of holding the event at the
sports center. The only other event scheduled for the sports center that evening is a fencing match
that would not have generated any additional costs or revenues. The fencing match can be held at
the local high school, but the rental cost of the high school gym would be $200 (consider this as an
added cost of holding basketball game at the campus sports center). The athletic director estimates
that the professional basketball game will require 20 hours of labor to prepare the building. Clean-
up depends on the number of spectators. The athletic director estimates the time of clean-up to be
equal to 2 minutes per spectator. The labor would be hired especially for the basketball game and
would cost $8 per hour. Utilities will be $500 greater if the basketball game is held at the sports
center (regardless of the number of spectators). All other costs would be covered by the
professional basketball team.

Required:

a. What is the variable cost of having one more spectator? What is the marginal cost of one
more spectator?

b. What is the cost of allowing the professional basketball team to use the sports center if
10,000 spectators are expected?

c. What is the opportunity cost of allowing the professional basketball team to use the sports
center if 12,000 spectators are expected?

d. What is the average cost per spectator if 10,000 spectators are expected? What if 12,000
are expected?
Solution:

Cost analysis for two alternatives

Sports Center High School Gym

Basketball Game Rental Cost of Gym = $ 200

Utilities charge = $ 500

Labor charge # = $ 160

#(20 hours * $ 8/hour=$160) to

prepare the building

Fencing Match Rental Charge = $ 200

The time for clean-up = 2 minutes per spectator

A) Average variable cost of having one more spectator = 8/60 * 2 = $ 0.27
Average marginal cost of having one more spectator will also be 0.27
B) Cost of allowing the professional basketball team to use the sports center if 10,000
spectators are expected = Total Fixed cost + Total Variable cost
= 200+ 500 + 160 + (10,000*2/60*8)
= $ 3526.67
C) The opportunity cost of allowing the basketball game to use the sports center will be the
amount to be paid as rental fee of high school gym to hold fencing match plus the excess
utilities if the basketball game is held at the sports center
Thus opportunity costs = $ 200 + $ 500 = $ 700
D) Average cost per spectator if 10,000 spectators are expected = $ 3,526.67/10,000 = $
0.3526
Average cost per spectator if 12,000 spectators are expected
=$ ( 200+500+160+12,000*2/60*8)/12,000
 = $0.3383
Problem 2. Fixed Costs and Allocated Costs

The maintenance department's costs are allocated to other departments based on the
number of hours of maintenance use by each department. The maintenance department has fixed
costs of $500,000 and variable costs of $30 per hour of maintenance provided. The variable costs
include the salaries of the maintenance workers. More maintenance workers can be added if
greater maintenance is demanded by the other departments without affecting the fixed costs of the
maintenance department. The maintenance department expects to provide 10,000 hours of
maintenance. Management is considering alternative methods of applying (charging) maintenance
department costs to departments.

Required:

a. What is an appropriate application rate for maintenance department services? What is the
average hourly maintenance cost?

b. What is the additional cost to the maintenance department of providing another hour of
maintenance? What type of cost is this: average, marginal, unit variable?

c. Maintenance department currently provides the necessary services and charges the user
departments based on hours of services provided. What problem may occur if the managers
of other departments can choose how much maintenance to use?

d. What problem exists if the other departments are allowed to go outside the organization to
buy maintenance services?

Solution:

Fixed cost for maintenance department = $ 500,000

Variable costs = $ 30/hour (Salaries)
Total hours of maintenance = 10,000

A) The average hourly maintenance cost

= (Total fixed cost + total variable costs)/Total hours of maintenance
= ($ 500,000 + 30* 10,000)/10,000
= $ 80
B) Additional cost to the maintenance department providing another hour of maintenance

Additional cost to the maintenance department of providing another hour will be the
variable cost of labor of $ 30 per hour.

C) Currently, the cost of maintenance is being allocated by the Maintenance Department to

the user departments based on the hours of maintenance service used. If the managers of
 other departments can choose how much maintenance to use, they can understate the
maintenance need for their department, thus overstating their departmental profit.
D) If other departments are allowed to go outside the organization to buy maintenance
services, they may benefit from low-cost maintenance service while the company’s own
maintenance will loose the demand for its own services and thus revenues.
Solution 3. Analyzing the Results from a Cost Regression Model

We have the following information for Tilbert Toys manufacturing firm.

Number Number of Setup

Month of setups setup hours Costs
1 195 920 $52,300
2 240 130 63,850
3 100 580 28,740
4 220 1,900 118,420
5 140 1,840 89,440
6 230 1,950 106,880
7 210 1,490 104,810
8 150 600 45,040
9 185 1,640 110,520
Required:
1. Estimate regression equation (using Excel of some other software).
a. Regress setup costs over number of setups
Y = 410.09x + 3905.3
R² = 0.3373

b. Regress setup costs over number of setup hours

Y = 40.943x + 29731
R² = 0.712

2. Plotted as above the initial data and the regression line for each regression (a) and (b).

3. For regression data we would recommend setup hours must be used to estimate upon setup
costs over number of setups for variety of reasons.

1) Goodness of Fit r2 = 0.34 for “Number of Setups” is Poor fit.

Goodness of Fit r2 = 0.85 for “Number of Setup hours” is a Good fit.

2) Significance of Independence t =1.89 is not significant at the 0.05 level for “Number of
Setups”
Significance of Independence t = 6.36 is significant at the 0.05 level for “Number of
Setups”
3) Setup hours looks as a better choice as more the number of hours to setup more will be
the setup costs. Number of setup doesn’t really tell us how much time was dedicated to the
setup as setup can be of various time periods.

Setup costs over number of

setups
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.580736
R Square 0.337255
Adjusted R
Square 0.242577
Standard
Error 28721
Observations 9
 Standa
Coefficien rd Lower Upper Lower Upper
ts Error t Stat P-value 95% 95% 95.0% 95.0%
- -
41439. 0.09424 0.92755 94082. 101893 94082 10189
Intercept 3905.348 1 3 7 6 .3 .6 3.3
- -
Number of 217.28 0.10106 103.70 923.88 103.7 923.88
setups 410.0909 28 1.88736 7 1 32 01 32

Setup costs over

setup hours
SUMMARY OUTPUT

Regression Statistics
0.84380
Multiple R 3
0.71200
R Square 4
Adjusted R 0.67086
Square 2
Standard
Error 18933
Observations 9

Standa
Coefficie rd Lower Upper Lower Upper
nts Error t Stat P-value 95% 95% 95.0% 95.0%
- -
29730.7 13632. 2.1808 0.0655 2505.3 61966. 2505.3 61966.7
Intercept 1 62 51 58 2 74 2 4
40.9433 9.8420 4.1600 0.0042 17.670 64.216 17.670 64.2160
Setup hours 1 58 36 42 54 08 54 8