Question

Davis Stores sells clothing in 15 stores located around the southwestern United States. The managers at Davis are considering expanding by opening new stores and are interested in estimating costs in potential new locations. They believe that costs are driven in large part by store volume measured by revenue. The following data were collected from last year’s operations (revenues and costs in thousands of dollars).

Store	Revenues	Costs
101	$4,180	$4,334
102	2,307	3,054
103	5,858	5,301
104	4,142	4,198
105	3,034	3,916
106	4,183	3,599
107	6,974	5,149
108	1,899	2,774
109	5,816	5,008
110	3,468	3,199
111	4,046	4,379
112	4,890	3,360
113	3,632	2,796
114	5,137	4,815
115	2,524	3,106

Required

a. Use the high-low method to estimate the fixed and variable portions of store costs based on revenues.

b. Managers estimate that one of the proposed stores will have revenues of $3.3 million. What are the estimated monthly overhead costs, assuming no inflation?

c. Managers are also considering a “mega-store” with revenues of $18 million. What are the estimated monthly overhead costs, assuming no inflation?

Answer 1

a.

Variable cost per unit = (Cost at highest revenue - Cost at lowest revenue) / (Highest revenue - Lowest revenue)

= ($5,149,000 - $2,774,000) / ($6,974,000 - $1,899,000)

= $2,375,000 / $5,075,000

= $0.46798

Fixed costs at lowest activity = Total cost - Variable cost

= $2,774,000 - ($1,899,000 * $0.46798)

= $2,774,000 - $888,695

= $1,885,305

Fixed costs at highest activity = Total cost - Variable cost

= $5,149,000 - ($6,974,000 * $0.46798)

= $5,149,000 - $3,263,695

= $1,885,305

b.

Estimated monthly overhead cost = Fixed costs + Variable cost

= $1,885,305 + ($3,300,000 * $0.46798)

= $1,885,305 + $1,544,335

= $3,429,640

c.

Estimated monthly overhead cost = Fixed costs + Variable cost

= $1,885,305 + ($18,000,000 * $0.46798)

= $1,885,305 + $8,423,645

= $10,308,950

Working notes:

In the calculation of variable cost, we take variable cost per dollar revenue is ($2,375,000 / $5,075,000).