The settlement from the insurance company was more than reasonable. The mean estimate excess cost of operations was roughly $254,000 but that is just the mean estimate. Unfortunately for Krog’s MetalFab Inc. we have zero confidence in this model’s exact mean estimate of $254,000. We are 95% confident that the estimated excess costs of operation was between roughly $9,600 using the lower 95% and almost $500,000 using the upper 95%. Because of this, the insurance company should have not immediately settled for $254,000 and should have only offered $9,600 as their starting settlement offer. Krog’s got a very good deal here.
The way that I figured out these numbers is by creating a regression to estimate the materials, labor, overhead, and I also created a model for overall cost estimation. The materials regression is a mixed cost model meaning that there are some fixed costs that we have but also have some variables costs that we are able to control based upon output. The R-square for this model is over 99% which is the goodness of fit which explains how well the model is able to explain the sum of the squared errors. The labor estimate is also a mixed cost because there is always a cost even at zero output. We still have some control over this variable as well depending on our output so it is mixed. This also has an R-square of over 99%. Finally, I used a mixed cost model as well for the overhead cost and the R-square was only 85% but I could have tightened this model up by dropping the Feb. outlier but I chose not to so that we could keep the dataset complete. The F-stat for all of the models were high which means that the overall regression model is statistically significant.
Krog’s does have an additional claim against the insurance company. Once again, we do not have any confidence in the mean estimate but we do have a 95% confidence interval. The mean estimate of the lost sales assuming a 7% increase in sales is $1,589,132. To...
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