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Criterion Regression 1 PDC A + (B × MP$) Regression 2 PDC A + (B × # of Pos) Regression 3 PDC A + (B × # of SS)

Regression 4 models purchasing department costs (PDC) as a function of the number of purchase orders and suppliers. It has a high goodness of fit, economically plausible variables, and insignificant residuals. Regression 4 is recommended over Regressions 2 and 3 from the previous problem. Regression 5 adds merchandise purchased dollars as a variable but it does not significantly improve the model. Regression 4 is recommended. Using Regression 4, the budgeted PDC for a store with $77M in purchases, 4,200 purchase orders, and 120 suppliers is estimated to be $1,343,860.

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Elliot Richard
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64 views3 pages

Criterion Regression 1 PDC A + (B × MP$) Regression 2 PDC A + (B × # of Pos) Regression 3 PDC A + (B × # of SS)

Regression 4 models purchasing department costs (PDC) as a function of the number of purchase orders and suppliers. It has a high goodness of fit, economically plausible variables, and insignificant residuals. Regression 4 is recommended over Regressions 2 and 3 from the previous problem. Regression 5 adds merchandise purchased dollars as a variable but it does not significantly improve the model. Regression 4 is recommended. Using Regression 4, the budgeted PDC for a store with $77M in purchases, 4,200 purchase orders, and 120 suppliers is estimated to be $1,343,860.

Uploaded by

Elliot Richard
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Regression 1 Regression 2 Regression 3

Criterion PDC = a + (b × PDC = a + (b × PDC = a + (b × # of Ss)


MP$) # of POs)
1. Economic  plausibility Result presented at Economically Economically plausible.
seminar by Couture plausible. The Increasing the number of
Fabrics found little higher the suppliers increases the costs
support for MP$ as a number of of certifying vendors and
driver. Purchasing purchase orders, managing the Designer
personnel at the the more tasks Wear-supplier relationship.
Miami store believe undertaken.
MP$ is not a
significant cost
driver.

2. Goodness of fit r = 0.08. Poor


2
r = 0.42.
2
r = 0.40. Reasonable 
2

goodness of fit. Reasonable goodness of fit.


goodness of fit.

3. Significance of t-value on MP$ of t-value on # of t-value on # of Ss of 2.32 is


independent variables 0.83 is insignificant. POs of 2.40 is significant.
significant.

4. Specification analysis
A. Linearity within the
relevant range Appears Appears Appears reasonable.
questionable but no reasonable.
strong evidence
against linearity.

B. Constant variance of Appears Appears Appears reasonable.


residuals questionable, but no reasonable.
strong evidence
against constant
variance.

C. Independence of Durbin-Watson Durbin-Watson Durbin-Watson


residuals Statistic = 2.42. Statistic = 1.99. Statistic = 2.00.
Assumption of Assumption of Assumption of
independence is not independence is independence is not
rejected. not rejected. rejected.

D. Normality of residuals Database too small Database too Database too small to make
to make reliable small to make reliable inferences.
inferences. reliable
inferences.
10-48 Purchasing department cost drivers, multiple regression analysis (continuation of
10-47). Barry Lee decides that the simple regression analysis used in Problem 10-47 could be
extended to a multiple regression analysis. He finds the following results for two multiple
regression analyses:

Regression 4: PDC = a + (b × No. of POs) + (b × No. of Ss)


1 2

Variable Coefficient Standard Error t-Value


Constant $ 481,186 $ 259,020 1.86
Independent variable 1: No. of POs $121.37 $58.04 2.09
Independent variable 2: No. of Ss $2,941 $1,458 2.02
r = 0.63; Durbin-Watson statistic = 1.91
2

Regression 5: PDC = a + (b × No. of POs) + (b × No. of Ss) + (b × MP$)


1 2 3

Variable Coefficient Standard Error t-Value


Constant $ 496,544 $ 311,137 1.60
Independent variable 1: No. of POs $122.73 $63.79 1.92
Independent variable 2: No. of Ss $2,996 $1,646 1.82
Independent variable 3: MP$ −0.00033 −0.0030 −0.11
r = 0.63; Durbin-Watson statistic = 1.92
2

The coefficients of correlation between combinations of pairs of the variables are as follows:

PDC MP$ No. of POs


MP$ 0.28
No. of 0.65 0.27
POs
No. of Ss 0.63 0.35 0.30

Required
1. Evaluate regression 4 using the criteria of economic plausibility, goodness of fit, significance of
independent variables, and specification analysis. Compare regression 4 with regressions 2 and 3
in Problem 10-47. Which one of these models would you recommend that Lee use? Why? 
2. Compare regression 5 with regression 4. Which one of these models would you recommend that
Lee use? Why? 
3. Lee estimates the following data for the Baltimore store for next year: dollar value of
merchandise purchased, $77,000,000; number of purchase orders, 4,200; number of suppliers,
120. How much should Lee budget for purchasing department costs for the Baltimore store for
next year? 
4. What difficulties do not arise in simple regression analysis that may arise in multiple regression
analysis? Is there evidence of such difficulties in either of the multiple regressions presented in
this problem? Explain. 
5. Give two examples of decisions in which the regression results reported here (and in Problem
10-47) could be informative.
SOLUTION
min.) Purchasing Department cost drivers, multiple regression analysis (continuation of 10-47). 

The problem reports the exact t-values from the computer runs of the data. Because the
coefficients and standard errors given in the problem are rounded to three decimal places,
dividing the coefficient by the standard error may yield slightly different t-values.

1. Regression 4 is a well-specified regression model:

Economic plausibility: Both independent variables are plausible and are supported by the
findings of the Couture Fabrics study.

Goodness of fit: The r2 of 0.63 indicates an excellent goodness of fit.

Significance of independent variables:  The t-value on # of POs is 2.09 while the t-value on # of
Ss is 2.02. These t-values are either significant or border on significance. 

Specification analysis: Results are available to examine the independence of residuals


assumption. The Durbin-Watson statistic of 1.91 indicates that the assumption of independence
is not rejected.

Regression 4 is consistent with the findings in Problem 10-47 that both the number of
purchase orders and the number of suppliers are drivers of purchasing department costs.
Regressions 2, 3, and 4 all satisfy the four criteria outlined in the text. Regression 4 has the best
goodness of fit (0.63 for Regression 4 compared to 0.42 and 0.40 for Regressions 2 and 3,
respectively). Most importantly, it is economically plausible that both the number of purchase
orders and the number of suppliers drive purchasing department costs. We would recommend
that Lee use Regression 4 over Regressions 2 and 3.

2. Regression 5 adds an additional independent variable (MP$) to the two independent variables
in Regression 4. This additional variable (MP$) has a t-value of –0.11, implying its slope
coefficient is insignificantly different from zero. The r2 in Regression 5 (0.63) is the same as that
in Regression 4 (0.63), implying the addition of this third independent variable adds close to zero
explanatory power. In summary, Regression 5 adds very little to Regression 4. We would
recommend that Lee use Regression 4 over Regression 5.

3. Budgeted purchasing department costs for the Baltimore store next year are
$481,186 + ($121.37×4,200) + ($2,941×120)  =  $1,343,860

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