.

,,
324 CHAPTER 7 Multiple Regression Analysis
CASES
-
CASE 7-1
approximate 95% prediction interval for your forecast. Do you feel your
analysis has yielded a useful tool for forecasting cheese uality? Explain.
24. The accounting numbers for major league baseball e given in Table P-24.
All figure's__cue in millions of dollars. The numerical va hies are GtReceit (Gate
Receipts), MeQ_iaRev (Media Revenue), StadRev tadium Revenue), TotRev
(Total Revenue}-PlayerCt (Player Costs), 0 xpens (Operating Expenses),
Oplncome Income= Total Re nue - Operating Expenses), and
Fran Valu (Franchise Val
a. Construct the correlation the variables GtReceit, MediaRev, ... ,
Fran Valu. From the correlat" n 1atrix, can you determine a variable that is
likely to be a good predictor n Valu? Discuss.
b. Use stepwise regression t uild a ode! for predicting franchise value using
the remaining variables. re you surpn d at the result? Explain.
c. Can we conclude tha , as a general rule, fr chise value is about twice total rev-
enue? Discuss.
d. Player costs are 1kely to be a big component of erating expenses. Develop an
equation for recasting operating expenses from p 1er costs. Comment on the
strength o the relation. Using the residuals as a guide, dentify teams that have
y low or unusually high player costs as a cor anent of operating
exp scs.
c. C nsider the variables other than Fran Valu. Given their definitions, arc there
groups of variables that are multicollinear? If so, identify these sets.
THE BOND MARKET
1
6
Judv Johnson, vice president of finance of a large,
private, investor-owned utility in the Northwest, was
faced with a financing problem. The company
needed money both to pay off short-term debts
coming due and to continue construction of a coal-
fired plant.
Judy called a meeting of her financial staff to
discuss the bond market problem. One member of
her staff, Ron Peterson, a recent M.B.A. graduate,
said he thought a multiple regression model could
be developed to forecast the bond rates. Since the
vice president was not familiar with multiple regres-
sion, she steered the discussion in another direction.
After an hour of unproductive interaction, Judy
then asked Ron to have a report on her desk the fol-
lowing Monday.
Judy's main concern was estimating the 10- or
30-ycar bond market; the company needed to decide
whether tu use equity financing or long-term debt.
To ntake this decision, the utility needed a reliable
forecast of the interest rate it would pay at the time
ol bond issuance.
Ron knew that the key to the development of a
good forecasting model is the identification or
1
"Thc clala for I his case study were provided by Dorothy Mercer, an Eastern Washington M.B.i\.
student. The analysis was clone by M.B.A. students Tak Fu. Ron Hand, Dorothy Nkrccr. Mill"\ Lou
ReclmoncL and Harold Wibon.
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independent variables that relate to the interest
rate paid by utilities at the time of bond issuance.
After discussing the problem with various people at
the utility. Ron decided to investigate the following
variables: a utility's bond rating (Moody's), a util-
ity's ratio of earnings to fixed charges, the U.S.
Treasury bond rates, the bond maturity (10 or 30
years), and the prime lending rate at the time of
issuance.
Ron gathered data he believed might correlate
with bond interest rates for utility bond issues dur-
ing two previous years. At first, he was uncertain
how to handle the utility bond rating. He finally
decided to consider only utilities whose ratings
were the same or slightly higher than that of his
company. This decision provided him with a sample
of 93 issues to analyze. But he was still worried
about the validity of using the bond ratings as inter-
val data. He called his former statistics professor
and learned that dummy variables would solve the
problem. Thus, he coded the bond ratings in the fol-
lowing way:
X
1
= l if the utility bond rating is A;
0 otherwise
X, 1 if the utility bond rating is AA;
0 otherwise
If the utility bond rating is BAA, both X
1
and X
2
are
II. The next step was for Ron to select a multiple
regression program from the computer library and
input the data. The following variables were
included in the full-model equation:
Variable I: Y = the interest rate paid by the utility
at the time of bond issuance
Variable 2: X
1
= 1 if the utility's bond rating is A
Variable 3: X
2
= 1 if the utility's bond rating is
AA
Variable 4: X:; = the utility's ratio of earnings to
fixed charges
Variable 5: X
4
= the U.S. Treasury bond rates (for
I 0 and 30 years) at the time of bond issuance
Variable 6: X
5
= the bond maturity (10 or 30
years)
Variable 7: X
6
= the prime lending rate at the
time of issuance
The actual data are presented in Appendix A.
Ron decided to analyze the correlation matrix
shown in 7-lK He was not surprised to find a
CHAPTER 7 Multiple Regression Analvsis 3 2 5
high positive relationship between the interest raiL:
paid by the utility at the time of bond issuance
the U.S. Treasury bond rate, r = .i)l{'l. I It: abu
expected a fairly high positive relationship between
the dependent variable and the prime lending rate
(r = .596). He was not too surprised to discover that
these two predictor variables were also related to
each other (potential multicollinearity. ,. . 713)
The negative relationship betwec:n the dependent
variable and length of bond maturity ( l 0 or
years), r = -.221, was also a result that mack sens,'
to Ron.
Next. Ron ran a full model t!1.:
predictor variables. Examination of the comput,:d
t values and/or the p-values, which are pn.:sented in
Table 7-19, indicated that perhaps the variable o!
ratio of earnings to fixed charges and certainl:-
the variable of prime interest rate were 1101
making a contribution to the forecast ol thL
interest rate paid by the utility at the time of bond
issuance.
To check his interpretation of the full regression
results, Ron decided to run a stepwise regression.
The output is shown in Table 7-20.
Although the p-value, .035, associated with the
t value for the ratio of earnings to fixed char;>;L'S i'
less than .05, Ron decided to drop tl1L' ':1ri:!:,!,_
Ratio from his regression equation. Furl llL 1 :'lif 'i" '1'
for this decision was provided by 1 he sm:1l! cn1 r e J:,
tion (r -c .. 097) of Ratio to the dependc:nL
Interest Rate. The results of the Miniudl \r,;
Ron's final model are shown in Table 7-2 i.
Ron's report to Judy included the
comments:
1. The best model, Interest= -1.28 -.Y29 J\1\- I.! S
AA + 1.23 Bond rates + 0.0615 M<ll uri t y.
explains 90.6% of the interest rate variation.
2. The standard error of the estimate is .''d h;tsL:d
on n = 93 observations. Thus, for a tore-
cast, Y. a 95% prediction interval for the :tctual
interest rate is Y 2( .53) or Y + J .06
3. The coefficients of the independent variable:-;
are all significant (very small p-valucs) am!
appear to be reliable. Multicollinearity is not a
problem.
Ron was very pleased with his effort and felt that
Judy would also be pleased.
CHAPTER 7 Multiple Regression Analysis
TABLE 7-18 Correlation Matrix for Bond Market Study .
Correlations
Interest Rate A AA Ratio Bond Rates Maturity
A -0.347
AA 0.173 -0.399
Ratio 0.097 0.037 0.577
Bond rates 0.883 -0.256 0.291 0.253
Maturity -0.221 0.278 0.010 0.094 -0.477
Prime 0.596 -0.152 0.342 0.255 0.713 -0.314
TABLE 7-19 Full-Model Run for Bond Market Study
Regression Analysis
The rcgression cquation is
Rates = -1.03 - 0. 829 A- 0. 889 AA- 0. 242 Ratio +Bond Rates
+ 0.0628 Maturity- 0.0031 Prime
Coef

-1.0263
A
-o. 8285
AJ'.
-0.8894
]-..;ctLJ_O
-0.2417
1\a Le:;
1.25753
l''1d t ur ty
0.062839
r;- ,
J: J.me
---0.00313
- 0. '123 5 R-Sq = 91.1%
tmal.ysis of Variance
Error
ToLal
DF
6
86
92
Unusual Observations
Obs
A
(,4
1. 00
f)(;
1.00
b I
1. 00
1.
0
J fi
1. 00
SE Coef
0. 6572
0. 1342
0.2248
0.1135
0.05964
0.006589
0.02720
R-sq (adj)
ss
240.907
23.567
264.474
Rate
15.5000
11.3000
12.3800
12.1500
T
-1.56
-6.17
-3.96
-2.13
21.08
9.54
-0.12
= 90.5%
MS
40.151
0.274
Fit
13.7645
13.4780
13.7897
13.7097
St
p
0.122
0.000
0.000
0.036
0.000
0.000
0.909
F
146.52
p
0.000
Dev Fit Residual St Resid
0.1627 1.7355 3.49R
0.1357 -2.1780 4 _ 31R
0.1297 -1.4097 -2. 78R
0.0947 -1.5597 - 3. 03R
T\ denoU:s an observation with a large standardized residual.
!. Wl1<tt questions do you think Judy will have for
Run'-'
l
l
I
i
,
!
TABLE 7-20 Stepwise Regression for Bond Market Study
Stepwise Regression: Int rate versus A, AA, . .
Alpha-to-Enter: 0.05 Alpha-to-Remove: 0.05
Response is Int rate on 6 predictors, with N= 93
Step 1 2 3 4 5
Constant
1.9818 -0.7641 -o. 7372 -0.2046 -1.0244
Bondrate
1.029 1.173 1.267 1.231 1. 253
T-Value
17.95 20.44 23.43 24.78 27.21
P-Value
0.000 0.000 0.000 0.000 0.000
Maturity
0.0439 0.0537 0.0588 0.0629
T-Value
5.25 7.02 8.37 9.60
P-Value
0.000 0.000 0.000 0.000
Ratio
-0.547 -0. 518 -0.241
'r-Value
-5.08 -5.29 -2.14
P-Value
0.000 0.000 0.035
A
-o. 56 -0.83
T-Value
-4.49 -6.28
P-Value
0.000 0.000
AA
-0.89
T-Value
-4.10
P-Value
0.000
s
0.800 0.704 0.623 0.565 0.521
~
P.-Sq 77.97 83.14 86.93 89.37 91.09
P.-Sq(adj) 77.73 82.76 86.49 88.88 90.58
Mallows Cp
123.6 75.7 41.2 19.6 5.0
TABLE 7-21 Final Model for Bond Market Study
Regression Analysis
The regression equation is
Interest P.ates -1.28-0.929 A- 1.18 AA-t-1.23 Bond Rates + 0. 0615 Matucicy
Predictor Coef SE Coef T p
Constant
-1.2765 0.6554 -1.95 0.055
A
-0.9293 0.1264 -7.35 0.000
AA
-1.1751 0.1781 -6.60 0.000
Rates
1.23308 0.05964 26.81 0.000
Maturity
0.061474 0.006649 9.25 0.000
s = o.s:no R-sq = 90.6% R-sq(adj) 90.2%
Analysis of Variance
Source DF ss MS F
p
P.egression
4 239.665 59.916 212.53 0.000
Residual Error
88 24.809 0.282
'I'ota1
92 264.474
Unusual Observations
Obs A Rate Fit St Dev Fit Residual St R e ~ ; i d
64
1. 00 15.5000 13.6956 0.0894 1.8044 3. 1l5R
6G
1.00 11.3000 13.6462 0.0898 -2.3462 -4.48R
67
1.00 12.3800 13.6462 0.0898 -1.2662 --4. 42R
68
1. 00 12.1500 13.6462 0.0898 -1.4962 -2.86R
R denotes an observation with a large standardized residual.
327
["
''
DATA FOR CASE 7.1
lnt rate
I
A
I
AA
I
Ratio
I
Bond rate
I
Maturity
I
Prime
I
14.75 0 0 2.01 12.57 10 20.5
14.5 0 0 2.53 12.57 10 20
14.13 1 0 2.1 12.57 10 20
14.63 0 1 4.13 12.14 30 20
14 1 0 2.1 12.57 10 20
13.38 0 1 3.97 12.57 10 20
14.57 0 1 3.27 12.14 30 20
13.88 1 0 3.5 13.19 10 19.5
15.38 0 0 2.85 13.19 10 19.5
15.63 0 0 1.81 13.12 10 18.5
15.88 1 0 2.72 12.69 30 18.5
15 1 0 2.43 13.12 10 18
16.13 0 0 3.27 12.69 30 18
15.25 0 1 3.13 12.69 30 17.5
16 0 0 2.55 13.68 10 17
16.25 0 0 2.08 13.68 10 17.5
17.38 0 0 2.12 13.2 30 17.5
16.35 1 0 3.4 14.1 10 19
17 1 0 2.63 13.6 30 19
16 0 1 2.61 14.1 10 19.5
16.63 1 0 2.06 14.1 10 19.5
16.38 0 0 2.08 14.1 10 20
16.75 1 0 2.09 13.6 30 20
15.13 0 1 4.29 12.69 30 20
16 1 0 2.5 12.96 30 20
14.5 0 1 3.32 13.47 10 20
16.25 0 0 2.95 12.96 30 20
16.88 0 0 1.85 14.28 10 20.5
17.38 0 0 1.55 13.59 30 20.5
16 0 1 3.33 14.28 10 20.5
16.75 1 0 2.77 14.94 10 20.5
17.13 0 0 2.18 14.94 10 20.5
17.5 0 1 4.21 14.67 30 20.5
17 1 0 2.66 15.32 10 19.5
16.75 0 1 3.58 15.32 10 19.5
17.2 0 1 2.96 15.32 10 19.5
18.75 0 0 1.93 15.32 10 19.5
17.5 0 1 2.57 14.68 30 19
17.5 0 0 3.18 15.15 10 18
18 0 0 1.93 15.15 10 18
15.63 0 0 2.2 13.39 10 17
14.75 1 0 2.21 13.39 10 17
15.25 0 1 3.24 13.35 30 16.5
15.75 1 0 2.35 13.35 30 16.5
15.25 1 0 2.11 13.39 10 16.5
15.75 1 0 2.8 13.35 30 16.5
15.63 0 0 1.95 13.39 10 16.5
16.13 0 0 2.8 13.39 10 16.5
r s ~
!'
-- -
''
15.75 1 0 4 13.35 30 16
16.13 0 0 2.81 13.5 10 15.8
16.25 1 0 3.38 13.5 30 15.8
16 0 0 2.57 13.5 10 15.8
15.88 0 1 3.96 13.5 30 15.8
16.5 1 0 2.67 13.5 30 15.8
16.38 1 0 3.05 13.5 30 15.8
12.5 1 0 2.36 10.6 30 15.3
12.25 1 0 2.54 10.6 30 15.3
14.25 1 0 2.2 12.13 30 15.3
15 1 0 3.03 12.13 30 15.8
15.25 1 0 3.24 12.13 30 16.5
16 0 0 1.95 12.34 30 17.8
14.88 1 0 2.86 12.34 30 17.8
14.75 1 0 2.64 12.34 30 19
15.5 1 0 2.23 11.4 30 20
13.75 1 0 2.24 11.4 30 19.5
11.3 1 0 3.24 11.36 30 17.5
12.38 1 0 1.95 11.36 30 17.5
12.15 1 0 2.32 11.36 30 14.5
11.75 1 0 2.45 9.81 30 13
12.38 1 0 1.88 9.81 30 13
12.63 0 0 1.76 9.81 30 13
11.13 1 0 1.99 9.81 30 12.5
11.38 0 0 2.2 9.78 10 12.5
11.88 1 0 2.14 9.81 30 12
11.75 1 0 2.61 9.81 30 12
13.63 0 0 1.84 10.24 30 11
13.88 0 0 1.62 11 30 11
13 1 0 3.56 11 30 11
12 1 0 2.65 11.1 10 11
13.13 1 0 2.65 11 30 11
14.27 0 0 1.8 11.34 30 12.3
14.63 0 0 1.69 11.34 30 12.3
15.25 0 0 1.88 11.34 30 12.2
14.25 1 0 2.77 11.34 30 12.3
13.52 1 0 2.22 11.75 10 13.5
14.63 1 0 2.42 11.59 30 13.5
14.75 0 0 1.77 11.39 30 13.5
14 0 0 2.22 11.75 10 13.5
14.5 0 0 2.99 11.59 30 13.5
14.25 0 0 2.22 11.75 10 13.5
14.63 0 0 1.93 11.75 10 14.5
13.3 1 0 3.35 12.68 10 15.5
14.5 0 0 2.21 12.68 10 17
z
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