Professor Dongwook Shin Fall 2022

ISOM2700 Operations Management

Practice Questions Set #3

(Solutions)

1. (Decision Tree) Eric Wong operates a real estate agency in Hong Kong that specializes in selling properties that
are hard to sell. He is approached by a client who has three properties to sell. The client indicates the prices he wishes
to receive for these properties as follows:

Property Price ($000s)

A 2,500

B 5,000

C 10,000

Eric would receive a commission of 4% on any of the properties he is able to sell.

The client has the following conditions:

“Eric, you have to sell the property A first. If you can’t sell it within a month, the entire deal is off--no commission
and no chance to sell the other properties. If you sell property A within a month, then I’ll give you the commission
for it and the option of (a) stopping at this point; or (b) trying to sell either B or C next under the same conditions
(i.e., sell within a month or no commission on the second property and no chance to sell the third property). If you
succeed in selling the first two properties, you will also have the option of selling the third.

After the client has left, Eric proceeds to analyze the proposal to determine whether or not to accept it. He figures
his selling costs and his chances of selling each property at prices set by the client to be:

Property Cost ($000s) Probability of Sale

A 80 .7

B 20 .6

C 40 .5

He believes that sale of a particular property would not make it any more or less likely that the two remaining
properties could be sold. Selling costs would have to be incurred whether or not a particular property is sold but
could be avoided by deciding not to attempt to sell the property.

Do you think Eric should accept the project? Why or why not? Draw the decision tree and discuss.
 ISOM2700 Practice Questions Set 3

As the return is positive ($137>0), Eric should accept the project. After A is sold, Eric should sell C since selling C
has a higher return than selling B ($230>$215).

2
 ISOM2700 Practice Questions Set 3

2. (Decision tree)

On Monday, a certain stock closed at $10 per share. On Tuesday, you expect the stock to close at $9, $10, or $11
per share, with respective probabilities 0.3, 0.3, and 0.4. On Wednesday, you expect the stock to close $1 lower,
unchanged, or $1 higher than Tuesday’s close, with the following probabilities.

Tuesday’s $1 $1
Close
Lower Unchanged Higher

$9 0.4 0.3 0.3

$10 0.3 0.5 0.2

$11 0.1 0.2 0.7

You are directed to buy 100 shares of the stock before the market starts on Thursday. All purchases are made at the
end of the day, at the known closing price for that day, so your only options are to buy now (end of Monday), at the
end of Tuesday, or at the end of Wednesday. The objective is to minimize the expected purchase price. Draw a
decision tree to decide when it is optimal to buy the stock.

The objective is to minimize the expected purchase price of the stock. ($10<$10.04) Thus, to buy the stock on
Monday is the optimal decision.

3
 ISOM2700 Practice Questions Set 3

3. (Value of Perfect Information) Consider the following payoff table:

Alternative Low Moderate High

Given that the probability of Low, Moderate and High are 0.3, 0.5 and 0.2 respectively. If we want to maximize our
payoff, what should be our decision: to build Small, Medium or Large facility? What should be the expected value
of perfect information?

EV(Small) = 0.3*10M + 0.5*10M + 0.2*10M = $10M

EV(Medium) = 0.3*7M + 0.5*12M + 0.2*12M = $10.5M

EV(Large) = 0.3*(-4M) + 0.5*2M + 0.2*16M = $3M

The expected value of medium is the highest. Therefore, we should build medium facility.

EVPI = (0.3*10M + 0.5*12M + 0.2*16M) – 10.5M = 12.2M – 10.5M = $1.7M

4
 ISOM2700 Practice Questions Set 3

4. (Resource Allocation: Linear Programming) A diet is being prepared for the University of Arizona dorms. The
objective is to feed the students at the least cost, but the diet must have between 1,800 and 3,600 calories. No more
than 1,400 calories can be starch, and no fewer than 400 can be protein. The varied diet is to be made of two foods:
A and B. Food A costs $0.75 per pound and contains 600 calories, 400 of which are protein and 200 starches. No
more than two pounds of food A can be used per resident. Food B costs $0.15 per pound and contains 900 calories,
of which 700 are starch, 100 are protein, and I 00 are fat. Write the equations representing this information.

Let A = pounds of food A

B = pounds of food B

Minimize: z = .75A + .15B

s.t. 600A + 900B ≤ 3,600 Maximum calories

600A + 900B ≥ 1,800 Minimum calories

200A + 700B ≤ 1,400 Maximum starch

400A + 100B ≥ 400 Minimum protein

A ≤ 2 Maximum amount of A

A, B ≥ 0 Non-negativity constraints

5
 ISOM2700 Practice Questions Set 3

5. (Linear programming)

Company XYZ manufactures three products A, B, and C. The production of these products requires three basic
resources Labor, Steel, and, Copper:

Product Quantity
Resources A B C Available
Labor 1 2 4 120
Steel 3 1 1 90
Copper 2 3 0 70
Market Price ($) 4 5 3

For example, one unit of product A requires 1 unit of labor, 3 units of Steel, and 2 units of Copper. The available
quantities of the resources are given in the last column, and the last row presents the per unit market price of the
three products.

Because of marketing considerations, the manager of the company wants the fraction of units of product C
produced to be at least 40% of the total number of units produced of the three products. According to historical
data, buyers of B use their credit card to pay while the buyers of A and C prefer to pay cash. For this reason, the
manager wants that the revenue ($) made from the sales of product B to be no more than the amount collected from
the sales of A and C together.

(1) Formulate a Linear Programming (LP) Problem that can help the manager find the best production
strategy.

Max 4xA + 5xB + 3xC

Subject to: xA + 2xB + 4xC ≤ 120 Maximum Labor

3xA + xB + xC ≤ 90 Maximum Steel

2xA + 3xB ≤ 70 Maximum Copper

xC ≥ 0.4(xA + xB + xC) Minimum proportion of C

5xB ≤ 4xA + 3xC Maximum sales of B

xA, xB, xC ≥ 0 Non-negativity of all variables

(2) The following table is from the sensitivity report given by the Excel Solver. Based on this table, answer the
following questions:

(a) What is the optimal production plan?

Optimal production quantity (From the Final Value):

xA = 20, xB = 10, xC = 20

6
 ISOM2700 Practice Questions Set 3

(b) If the market price of Product B drops to $2 per unit, will the current production plan still be optimal? Why
or why not?

No, because the decrease $3 (= 5 – 2) is more than allowable decrease 2.909.

(c) If the market price of Product A changes from the current price to $7 per unit, how much additional
revenue can the company earn?

Since increase $7 - $4 = $3 is less than allowance increase 9.4, the current production plan is still optimal where
xA= 20. Therefore, additional revenue earned is $3*20 = $60.

7
 ISOM2700 Practice Questions Set 3

6. (Advanced Problem: Linear programming)

The All-Colorful Company produces a variety of paint products. Demand is highly seasonal, and the forecasted
demand (in gallons) for the next 4 quarters is given as follows:

Quarter 1 Quarter 2 Quarter 3 Quarter 4

Demand Forecast 300,000 850,000 1,500,000 350,000

The All-Colorful Company has a regular-time production capacity of 90,000 working hours per quarter for
Quarters 1, 2, and 4, and the regular-time production capacity of Quarter 3 is 150,000 working hours. Besides
regular-time production, the All-Colorful Company can also use overtime production or subcontracting. The
maximum overtime working hours in any quarter is 20% of regular-time capacity. Each gallon requires 0.2
working hour of production. The subcontractor can supply a maximum of 200,000 gallons per quarter.

The All-Colorful Company has an initial inventory of 250,000 gallons at the beginning of Quarter 1, and the
ending inventory at the end of Quarter 4 should be 300,000 gallons. Regular-time cost is $10 per hour, overtime
cost is $15 per hour, subcontracting cost is $4 per gallon, and the inventory holding cost is $3 per gallon per
quarter. Assume no backorders or stockouts are permitted. Formulate a linear program to determine the best
production plan.

Let: D𝑡 = Demand forecast for quarter t

CR 𝑡 = Regular-time capacity (in hours) at quarter t

(1) If assume all regular-time labor work at full capacity.

Decision variables:

O𝑡 = Overtime hours used in quarter t

C𝑡 = Number of gallons subcontracted for quarter t

I𝑡 = Ending inventory at quarter t

Objective function:

Min ∑4𝑡=1 15 O𝑡 + ∑4𝑡=1 3 I𝑡 + ∑4𝑡=1 4 C𝑡

Subject to:

I𝑡 = I𝑡−1 + 5(CR 𝑡 + O𝑡 ) + C𝑡 − D𝑡 , ∀ t = 1, 2, 3, 4

O𝑡 ≤ 20%CR 𝑡 , ∀ t = 1, 2, 3, 4

C𝑡 ≤ 200,000, ∀ t = 1, 2, 3, 4

I0 = 250,000 I4 = 300,000

(2) If assume the company can choose how many regular hours to use.

Decision variables:

O𝑡 = Overtime hours used in quarter t

8
 ISOM2700 Practice Questions Set 3

C𝑡 = Number of gallons subcontracted for quarter t

I𝑡 = Ending inventory at quarter t

R 𝑡 = Number of regular-time hours used in quarter t

Objective function:

Min ∑4𝑡=1 15 O𝑡 + ∑4𝑡=1 3 I𝑡 + ∑4𝑡=1 4 C𝑡 + ∑4𝑡=1 10 R 𝑡

Subject to:

R 𝑡 ≤ CR 𝑡 ∀ t = 1, 2, 3, 4

I𝑡 = I𝑡−1 + 5(R 𝑡 + O𝑡 ) + C𝑡 − D𝑡 , ∀ t = 1, 2, 3, 4

O𝑡 ≤ 20%CR 𝑡 , ∀ t = 1, 2, 3, 4

C𝑡 ≤ 200,000, ∀ t = 1, 2, 3, 4

I0 = 250,000 I4 = 300,000

In (1), ∑4𝑡=1 10 𝐶𝑅𝑡 is a constant, it can be omitted from objective function.

9
 ISOM2700 Practice Questions Set 3

7. (Advanced Problem: Linear programming)

A pottery manufacturer manufacturers four different types of dining room service sets: English, Currier, Primrose,
and Bluetail. Furthermore, Primrose can be made by two different methods.

Each dining service set uses clay, enamel, dry room, and kiln time, in quantities shown in the table below. The
rightmost column in the table shows the manufacturer’s resource availability for the remainder of the week. Notice
that Primrose can be made by two methods. Both methods use the same amount of clay (10 lbs.) and dry time (6
hours). But the second method uses one pound of enamel and occupies three more hours in the kiln.

The manufacturer is currently committed to making the same amount of Primrose using methods 1 and 2. Assume,
for simplicity, that the numbers of sets of each type don’t have to be integers.

1) Formulate a linear program to maximize the total earnings.

Decision variables E, C, P1, P2, B are the number of sets of type English, Currier, Primrose Method 1,
Primrose Method 2, and Bluetail, respectively.

Max 51 E + 102 C + 66 P1 + 66 P2 +89B

Subject to:

Clay: 10 E + 15 C + 10 P1 + 10 P2 + 20 B <= 130

Enamel: E + 2 C + 2 P1 + P2 + B <= 13

Dry Room: 3 E + C + 6 P1 + 6 P2 + 3 B <= 45

Kiln: 2 E + 4 C + 2 P1 + 5 P2 + 3 B <= 23

Primrose Equal: P1 - P2 = 0

Non-negativities: E, C, P1, P2, B >= 0

2) The following table is from the sensitivity report given by the Excel Solver. Based on this table, answer
questions (a)-(g).

10
 ISOM2700 Practice Questions Set 3

(a) What is the optimal manufacturing strategy?

From the Final Value under Adjustable Cells, E=0, C=2, P1=0, P2=0, B=5

(b) What’s the optimal total earnings?

Optimal total earnings, Z = 51 E + 102 C + 66 P1 + 66 P2 +89B

= 51*0 + 102*2 + 66*0 + 66*0 + 89*5 = $649

(c) Suppose that the manufacturer can purchase an additional 20 lbs of clay for $1.10 /lb. Should the
manufacturer make this purchase? Why or why not?

Clay is a binding constraint with a shadow price of $1.43/lb which is larger than the unit cost $1.10, and since 20
lbs is less than allowable increase 23.33 lb, the manufacturer should make this purchase.

(d) Suppose the manufacturer makes the purchase mentioned in part (c), that is, he has purchased an additional
20 lbs of clay for $1.10 /lb. By how much the total earnings will change?

The net profit for every additional lb of clay is $1.43-$1.10=$0.33/lb, which remains valid for the first 23.33
additional units (allowable increase). So since 20 lbs < 23.33 lbs, the net impact on the objective is $0.33 * 20 =
$6.6.

(e) Suppose that some of the workers of the Dry Room area are organizing a strike. If the strike takes place the
number of hours available in the Dry Room would decrease from its current value to 20 hours. What is the
maximum amount of money that the manufacturer is willing to offer the workers of the Dry Room area to
cancel the strike?

Dry Room is not a binding constraint and has an allowable decrease of 28 hours. Since this allowable decrease is
greater than the effective decrease of 25 hours due to the strike you should not offer any compensation to the
workers to stop the strike.

(f) Suppose now that all the workers in the Dry Room area are organizing the strike. In this case, if the strike
takes place the number of hours available in the Dry Room would decrease to 0. What is the maximum that
the manufacturer is willing to pay in this case to stop the strike? Briefly explain your answer.

In this case, we know that the manufacturer will not be able to produce anything and so the total earning under a
strike would be Z=0. Currently, Z=$649 (part b), and so the maximum that the manufacturer will pay is $649.

11
 ISOM2700 Practice Questions Set 3

8. (Linear programming)

AA diet is being prepared for the University of Arizona dorms. The objective is to feed the students at the least
cost, but the diet must have between 1,800 and 3,600 calories. No more than 1,400 calories can be starch, and no
fewer than 400 can be protein. The varied diet is to be made of two foods: A and B. Food A costs $0.75 per pound
and contains 600 calories, 400 of which are protein and 200 starches. No more than two pounds of food A can be
used per resident. Food B costs $0.15 per pound and contains 900 calories, of which 700 are starch, 100 are
protein, and 100 are fat.

Formulate a linear program that solves for the optimal diet plan with the least cost, and solve it using the graphical
method. What’s the optimal diet plan?

Let A = pounds of food A

B = pounds of food B

Minimize: z = .75A + .15B

s.t. 600A + 900B < 3,600 Maximum calories (1)

600A + 900B > 1,800 Minimum calories (2)

200A + 700B < 1,400 Maximum starch (3)

400A + 100B > 400 Minimum protein (4)

A < 2 Maximum amount of A (5)

A, B > 0 Non-negativity of both variables

The optimal point is the cross point of the line (4): 200A + 700B =140 and the line (3): 400A + 100B = 400, thus
A=7/13≈0.54, B=24/13≈1.85, the minimum cost is 0.75*0.54+0.15*1.85≈$0.68

12