You are preparing to negotiate with FarOut Products for a co

You are preparing to negotiate with Far-Out Products for a contract to perform research and development. For one work task, Far-Out is proposing 1800 labor hours and $80,000 of material. Both the technical analyst 2nd the auditor have examined the material cost. Both agree that there is a relationship between labor hours and material cost. Both also agree in the accuracy of the data below from recent similar projects (all data adjusted for inflation):

Project Labor-Hours Expended Material Dollars Expended

1 1,000 $ 50,000

2 1,100 $ 52,000

3 1,900 $ 74,000

4 2,000 $ 73,500

5 1900 $ 74,400

Total 7900 323,900

1. Using the data, the auditor recommended a cost estimating relationship (CER) developed using a simple average, $41 per labor hour ($323,900/7909). Using the auditor’s analysis, what would be you estimate of material cost for this task?

2. Using the same data, the technical analyst developed a CER using regression analysis. The equation is $24,117 + ($25.74 x number of labor hours) with an R2 of .988. Using the analyst\'s analysis, is, what would be your estimate of material cost for the task?

3. Which estimate appears more accurate? Why?

Solution

1. As per auditors simple average, material cost would be $ 41 x 1800 labour hours = $ 73,800

2. As per technical analyst anaylysis material cost would be $ 24117 + ($25.74 x 1800) = $70, 449

3. Anaylsis of technical analyst appears to be more accurate becuase of underlying rationalle behind the linear equation which he should have taken into consideration. Estimate by auditor is just weighted average calculation without any basis.