CHAPTER 9

Case Study 9—An Exercise in Cost Estimation to Determine Saved Expenses

So far all the previous case studies have concerned themselves mainly with forecasting “but for” sales, that is, those sales that would have occurred but for the actions of the defendant or an insured peril. In this case study we demonstrate how an uncritical application of cost estimation theory can serve to produce an incorrect damages award.

Classifying Cost Behavior

We generally classify cost behavior into three major categories—those that vary directly with sales we call variable costs or expenses, those that do not vary with sales we call fixed costs or expenses, and those that vary somewhat with sales we call semivariable or semifixed costs or expenses. Examples of each are raw materials or purchased merchandise for variable costs, rent for a fixed cost, and telephone expense, where the base monthly charge is a fixed element of the cost and long-distance charges are the variable element.

If we think of these three cost categories in statistical terms, specifically in terms of the slope and intercept, or constant, of a regression line, we might say that a truly variable cost would exhibit a slope but no intercept, or an intercept of zero; that a truly fixed cost would exhibit an intercept but no slope; and that a semifixed cost would exhibit both an intercept and a slope.

In terms of a percentage of sales, true variable costs would maintain the same percentage of sales whether those sales were ...

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