Chapter 8 Slides

PERFORMANCE OPERATIONS P1
UNIT 2
Chapter 8-Forecasting Techniques
Chapter overview
ØThe High-Low method

ØRegression
ØTime Series Analysis
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The High-Low method
ØMethod of breaking semi-variable costs into their 2 components

ØFixed & Variable
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The High-Low method
Step 1
• Determine the variable cost using highest and lowest output (&activity)
• Variable cost per unit = Δ𝐶𝑜𝑠𝑡
Δ𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦
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The High-Low method
Step 2
• Determine the fixed cost
• Total cost = Fixed cost + Variable cost (for total output)
• Therefore : Fixed cost = Total cost –Variable Cost (for total output)
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The High-Low method
Step 3
• Calculate the expected cost
• Total expected future costs = Fixed cost + (Forecast production units X
Variable cost per unit)
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Regression analysis
ØMethod takes account of all observations unlike High-Low which only

takes account of 2 observations.
ØLinear regression formula is used to estimate the relationship between
the variables
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Regression analysis
Formula
y=𝑎+𝑏𝑥
y= dependent variable
a = intercept (on y-axis)
b = gradient
x = independent variable
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Regression analysis
Linear regression analysis can be used to make forecasts or estimates

whenever a linear relationship is assumed between two variables, and
historical data is available for analysis.
Two such relationships are:
•Time series and trend line (Alternative for calculating moving averages)
•High-low method ( Alternative for using high-low method)
9
Regression analysis
Linear regression analysis can be used to make forecasts or estimates

whenever a linear relationship is assumed between two variables, and
historical data is available for analysis.
Two such relationships are:
•Time series and trend line (Alternative for calculating moving averages)
•High-low method ( Alternative for using high-low method)
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Regression analysis -Correlation
Regression analysis attempts to find the linear relationship between two

variables. Correlation is concerned with establishing how strong the
relationship is.
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The correlation coefficient
The degree of correlation can be measured by the Pearsonian correlation
coefficient, r (also known as the product moment correlation coefficient).r
must always be between –1 and +1.
If r = 1, there is perfect positive correlation
If r = 0, there is no correlation
If r = –1, there is perfect negative correlation
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3 Degrees of correlation
1.Perfectly correlated
2. Partly correlated
3. Uncorrelated
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The coefficient of determination
This measures how good the estimated regression equation is, designated
as r2(read as r-squared). The higher the r-squared, the more confidence
one can have in the equation.
Statistically, the coefficient of determination represents the proportion of
the total variation in the y variable that is explained by the regression
equation. It has the range of values between 0 and 1.
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Regression analysis
Limitations
• Assumes a linear relationship between the variables
• Only measures the relationship between 2 variables
• Only interpolated forecasts ted to be reliable
• Regression assumes that the historical behavior of the data continues into the
foreseeable future
• Interpolated predictions are only reliable if there is a significant correlation between
the data
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Time Series Analysis
ØA record of values over time.
ØEg. Unemployment over a period of 10 years
ØAnalysis of components can provide information for forecasting.
ØThe trend is the underlying increase or decrease in value.
ØAnalysis can assist in identifying and measuring any seasonal variations around the trend
Therefore: A trend over time, established from historical data, and adjusted for
seasonal variations, can be used to make predictions for the future.
16
A time series has 4 components:
(1) The trend (T)-Upward, downward or sideways trend.
(2) Seasonal variations (S)-Seasonal variations are short-term fluctuations in value due to
different circumstances which occur at different times of the year.
(3) Cyclical variations (C)-Medium-term to long term influences usually associated with the
economy.
(4) Residual variations (R)- The difference between the actual value and the figure
predicted using the trend, the cyclical variation and the seasonal variation
We are primarily interested in the first 2 (Trend and Seasonal variations)
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Calculation of Trend
(1) Inspection. The trend line can be drawn by eye with the aim of plotting the line so that
it lies in the middle of the data.
(2) Least squares regression analysis. The x axis represents time and the periods of time
are numbers, e.g. January is 1, February is 2, March is 3, etc.
(3) Moving averages. This method attempts to remove seasonal or cyclical variations by a
process of averaging.
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Calculation of Seasonal Variations
(1) Additive model
(2) Multiplicative Model
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Forecasting equation:
Prediction = Trend + Seasonal variations
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END.

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PERFORMANCE OPERATIONS P1

ØThe High-Low method

ØMethod of breaking semi-variable costs into their 2 components

ØMethod takes account of all observations unlike High-Low which only

Linear regression analysis can be used to make forecasts or estimates

Linear regression analysis can be used to make forecasts or estimates

Regression analysis attempts to find the linear relationship between two

(2) Multiplicative Model

Prediction = Trend + Seasonal variations

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