. Alternative Uses of Capacity. Harris Equipment built a new facility five years ago but is using only 60 percent of its capacity to produce several machining equipment product lines. Management would like to use the excess capacity and has three possibilities. Only one of the three can be selected.

(a) Harris could produce an additional 600 units per year of its most popular machine and focus marketing efforts on European metal parts producers. Management estimates that additional freight costs would amount to \(\$ 550\) per machine and fixed factory overhead would increase by \(\$ 150,000\). To cover the additional cost, the selling price per machine on European sales would be increased by \(\$ 800\) per machine. Incremental international selling costs would be about \(\$ 200,000\) per year. Harris has earned a contribution margin of \(\$ 1,800\) on each unit in the past.

(b) Harris could produce and market a smaller model of an existing laser lathe. The capacity could be used to produce 200 units per year that would sell for \(\$ 15,500\) each. Management has estimated the following unit variable costs.

The new lathe would add fixed costs of \(\$ 700,000\) to fixed overhead expenses and \(\$ 250,000\) to fixed selling expenses.

(c) Olson Testing Company has offered to lease the facilities at \(\$ 30,000\) per month plus 2 percent of the net revenues generated from the facilities by Olson. Net revenues are estimated at \(\$ 15,000,000\) per year.
\section*{Required:}
1. Which of the three alternatives should management select? Comment on the relative riskiness.
2. What is the opportunity cost of this decision?

Transcribed Image Text:

Prime costs Variable overhead Variable selling. Total costs. $ 4,500 2,000 500 $ 7,000