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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:
| A6 | EX4 | |
| $ 200 | $ 300 | Selling price |
| $ 120 | $ 200 | Variable |
| $ 30 | $ 70 | Variable marketing cost per unit |
| 1.0 | 0.5 | Hours required to produce one unit on the regular machine |
| $700,000 | $1,100,000 | Budgeted total fixed |
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 $140 per unit. (It takes 1 hour to produce one unit of V2
on the regular machine, and variable marketing cost equals $30 per unit.) What product mix should
Gormley choose to maximize operating income? Show your calculations
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