Reference no: EM131180591

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.