Case Study 6—Cross-Sectional Regression Combined with Seasonal Indexes to Determine Lost Profits

This case study concerns the calculation of lost profits that the plaintiff alleges were caused by the tortious acts of the company's general manager. After soliciting its customers and employees, the general manager left the employ of Precision Machine Works, L.P. at the end of March 2007, which the plaintiff alleges resulted in it suffering operating losses for a two-year period.

Outline of the Case

An issue we had to deal with early on was that forecasting incremental sales was made problematical by the company's completed contract accounting method that produced monthly sales figures that showed no trend or pattern. We were able to deal with this in two ways. First, monthly sales were converted to quarterly sales, which removed much of the randomness from the data; and second, we discovered that the company's machine shop sales in the oil patch section of Houston, TX are highly correlated with the spot price of crude oil. Because of this, we were able to use a multiple regression model that included the predictor variables seasonal indexes and the spot price of oil to calculate incremental sales. Incremental cost of sales and operating expenses were developed for the interruption and recovery periods by regressing these variables against sales.

A schedule of monthly sales of the Precision Machine Works, L.P. for the period beginning April 2004 and ending June 2008 is ...

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