Reference no: EM131665618

Question: Product mix, special order. (N. Melumad, adapted) Gormley Precision Tools makes cutting tools for metalworking operations. It makes two types of tools: A6, a regular cutting tool, and EX4, a highprecision cutting tool. A6 is manufactured on a regular machine, but EX4 must be manufactured on both the regular machine and a high-precision machine. The following information is available:

Additional information includes the following:

a. Gormley faces a capacity constraint on the regular machine of 50,000 hours per year.

b. The capacity of the high-precision machine is not a constraint.

c. Of the $1,100,000 budgeted fixed overhead costs of EX4, $600,000 are lease payments for the highprecision machine. This cost is charged entirely to EX4 because Gormley uses the machine exclusively to produce EX4. The company can cancel the lease agreement for the high-precision machine at any time without penalties.

d. All other overhead costs are fixed and cannot be changed.

1. What product mix-that is, how many units of A6 and EX4-will maximize Gormley's operating income? Show your calculations.

2. Suppose Gormley can increase the annual capacity of its regular machines by 15,000 machine-hours at a cost of $300,000. Should Gormley increase the capacity of the regular machines by 15,000 machinehours? By how much will Gormley's operating income increase or decrease? Show your calculations.

3. Suppose that the capacity of the regular machines has been increased to 65,000 hours. Gormley has been approached by Clark Corporation to supply 20,000 units of another cutting tool, V2, for $240 per unit. Gormley must either accept the order for all 20,000 units or reject it totally. V2 is exactly like A6 except that its variable manufacturing cost is $130 per unit. (It takes 1 hour to produce one unit of V2 on the regular machine, and variable marketing cost equals $20 per unit.) What product mix should Gormley choose to maximize operating income? Show your calculations.