Topic 9

Binary optimization
Financial Modeling – Autumn 2023
SUMMARY

Integer Variables and Binary Variables.

Binary Variables and Binary Choice Model.

Binary Variables and Logical Relationships.

The Facility Location Model.

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BINARY CHOICE
MODELS
Binary choice models, also known as binary response models or binary
outcome models, are statistical models used to analyze situations where
the dependent variable (response variable) can take one of two possible
outcomes (e.g., success/failure, buy/do not buy, yes/no). These models
are particularly useful in fields like economics, sociology, and psychology
for modeling decisions or behaviors that have binary outcomes.

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EXAMPLE

Division A of the Marr Corporation has been allocated $160 million for capital projects this year.
Managers in Division A have examined various possibilities and have proposed five projects for Marr’s
capital budgeting committee to consider. The projects cover a variety of activities, as the following list
shows:
There is just one project of each type. Each project has an estimated NPV and each requires a capital
expenditure, which must come out of the budget for capital projects. The following table summarizes
the possibilities, with all figures in millions of dollars:

Project

P1 P2 P3 P4 P5

NPV $10 $17 $16 $8 $14

Expenditure $48 $96 $80 $32 $64

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EXAMPLE

▪ We can formulate this problem as an allocation model with one constraint. To

construct an algebraic model, we let
▪ 𝑦𝑗 = 1 if project j is accepted; and 0 otherwise
▪ The decision variables 𝑦𝑗 represent binary choice. When 𝑦𝑗 = 1, project j is
selected to be part of the set of projects undertaken; when 𝑦𝑗 = 0, project j is
rejected.
▪ Only these two binary values have meaning as decisions. An algebraic statement
of the model is the following:
▪ Maximize z = 10 𝑦1 + 17 𝑦2 + 16 𝑦3 + 8 𝑦4 + 14 𝑦5
▪ subject to 48 𝑦1 + 96 𝑦2 + 80 𝑦3 + 32 𝑦4 + 64 𝑦5 ≤ 160

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BINARY VARIABLES AND
LOGICAL
RELATIONSHIPS
In mathematical modeling, binary variables often play a crucial role
in representing logical relationships and conditions. They can be
used to model constraints, decisions, and scenarios where logical
decisions are required. For instance, you might use binary variables
to represent “if-then” relationships or to encode situations like
“either A or B but not both” by setting up appropriate constraints.

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Emergency Coverage in Metropolis

The city of Metropolis is in the process of designing a new public emergency system, and
their design calls for locating emergency vehicles around the city. The city is divided into
nine districts, and seven potential sites have been identified as possible locations for
emergency vehicles. Equipment located at each potential site can reach some (but not all) of
the districts within the 3-minute time requirement specified by the city

The city wants to provide coverage to all nine districts within the specified time, using the
minimum number of sites.
In the following table, an entry of 1 means that the district can be serviced from the
corresponding site within the time requirement.

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Emergency Coverage in Metropolis

Site S1 S2 S3 S4 S5 S6 S7
District D1 0 1 0 1 0 0 1
D2 1 0 0 0 0 1 1
D3 0 1 0 0 0 1 1
D4 0 1 1 0 1 1 0
D5 1 0 1 0 1 0 0
D6 1 0 0 1 0 1 0
D7 1 0 0 0 0 0 1
D8 0 0 1 1 1 0 0
D9 1 0 0 0 1 0 0

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Constraints

▪ Minimize z = 𝑦1 + 𝑦2 + 𝑦3 + 𝑦4 + 𝑦5 + 𝑦6 + 𝑦7
subject to:

𝑦2 + 𝑦4 + 𝑦7 ≥1
𝑦1 + 𝑦6 + 𝑦7 ≥1
𝑦2 + 𝑦6 + 𝑦7 ≥1
𝑦2 + 𝑦3 + 𝑦5 + 𝑦6 ≥1
𝑦1 + 𝑦3 + 𝑦5 ≥1
𝑦1 + 𝑦4 + 𝑦6 ≥1
𝑦1 + 𝑦7 ≥1
𝑦3 + 𝑦4 + 𝑦5 ≥1
𝑦1 + 𝑦5 ≥1
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THE FACILITY LOCATION
MODELS
The facility location model is an optimization model used in
operations research and logistics. It addresses the problem of
determining the optimal locations for facilities (such as
warehouses, distribution centers, or service centers) to minimize
costs while meeting demand from a set of locations (customers
or demand points).

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THE FACILITY LOCATION MODELS

The facility location model is a type of optimization model used to

determine the optimal locations for facilities, such as warehouses,
factories, or service centers, in a network to meet certain objectives.
These objectives can include minimizing transportation costs,
maximizing service coverage, or balancing workloads.

The facility location problem typically involves deciding where to place

facilities among a set of potential locations while considering factors like
demand, supply, transportation costs, and capacity constraints. This
model is essential in supply chain management, logistics, and urban
planning, and it can be formulated as a linear programming or integer
programming problem.
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 Levinson Foods Company

Levinson Foods is in the process of expanding its distribution system. After some planned
acquisitions, the company will have ten distribution centers, with monthly volumes (in
cartons) as listed below. Six of these sites will be able to support warehouses, in terms of the
infrastructure available, and are designated by (W).

Center Volume Center Volume

Albuquerque (W) 3,200.00 Oklahoma City 3,500.00
Boise 2,500.00 Phoenix (W) 5,000.00
Dallas (W) 6,800.00 Salt Lake City 1,800.00
Denver (W) 4,000.00 San Antonio (W) 7,400.00
Houston (W) 9,600.00 Wichita 2,700.00
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 Levinson Foods Company

Because the properties have been acquired under different circumstances, they would have
different characteristics if Levinson Foods were to open warehouses at the sites. Their
potential capacities (in cartons) and monthly operating costs are summarized in the following
table:
Warehouse Capacity Cost
Albuquerque (W) 16,000.00 $140,000.00
Dallas (W) 20,000.00 $150,000.00
Denver (W) 10,000.00 $100,000.00
Houston (W) 10,000.00 $110,000.00
Phoenix (W) 12,000.00 $125,000.00
San Antonio (W) 10,000.00 $120,000.00
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 Levinson Foods Company

Warehouse Fixed Cost Alb Boise Dall Denv Hous Okla Phoe Salt SanA Wich Capacity

Albuquerque (W) $140,000.00 $0.00 $47.00 $32.00 $22.00 $42.50 $27.00 $23.00 $30.00 $36.50 $29.50 16,000.00

Dallas (W) $150,000.00 $32.00 $79.50 $0.00 $39.00 $12.50 $10.50 $50.00 $63.00 $13.50 $17.00 20,000.00

Denver (W) $100,000.00 $21.00 $42.00 $39.00 $0.00 $51.50 $31.50 $40.50 $24.00 $47.50 $26.00 10,000.00

Houston (W) $110,000.00 $42.50 $91.00 $12.50 $51.50 $0.00 $23.00 $58.00 $72.00 $10.00 $31.00 10,000.00

Phoenix (W) $125,000.00 $23.00 $49.00 $50.00 $40.50 $58.00 $49.00 $0.00 $32.50 $50.00 $52.00 12,000.00

San Antonio (W) $120,000.00 $36.50 $83.50 $13.50 $47.50 $10.00 $24.00 $50.00 $66.50 $0.00 $32.00 10,000.00

Volume 3,200.00 2,500.00 6,800.00 4,000.00 9,600.00 3,500.00 5,000.00 1,800.00 7,400.00 2,700.00

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Levinson Foods Company

▪ Objective function (minimize): Total Fixed Cost + Total Variable Cost

▪ Total Fixed Cost = 140 𝑦1 + 150 𝑦2 + 100 𝑦3 + 110 𝑦4 + 125 𝑦5 + 120 𝑦6
▪ Total variable cost = σ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦𝑖,𝑗 ∗ 𝐶𝑜𝑠𝑡𝑖,𝑗
▪ Constraints:
▪ 𝑦1 , 𝑦2 , 𝑦3 , 𝑦4 , 𝑦5 , 𝑦6 must be binary value
▪ ∑𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦𝑖,𝑗 ≤ 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦𝑦
▪ ∑𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦𝑖,𝑗 ≥ 𝐷𝑒𝑚𝑎𝑛𝑑𝑦

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