Chapter 3

Modeling and Solving LP

Problems in a Spreadsheet
 Introduction to Linear Programming
 A Linear Programming model seeks to
maximize or minimize a linear function,
subject to a set of linear constraints.
 The linear model consists of the following
components:
– A set of decision variables.
– An objective function.
– A set of constraints.

2
 Introduction to Linear Programming
 The Importance of Linear Programming
– Many real world problems lend themselves to linear
programming modeling.
– Many real world problems can be approximated by
linear models.
– There are well-known successful applications in:
Manufacturing
Marketing
Finance (investment)
Advertising
Agriculture
3
 Introduction to Linear Programming
 The Importance of Linear Programming
– There are efficient solution techniques that solve
linear programming models.
– The output generated from linear programming
packages provides useful “what if” analysis.

4
 Introduction to Linear Programming
 Assumptions of the linear programming
model
– The parameter values are known with certainty.
– The objective function and constraints exhibit
constant returns to scale.
– There are no interactions between the decision
variables (the additivity assumption).
– The Continuity assumption: Variables can take on
any value within a given feasible range.

5
 The Galaxy Industries Production
Problem –
A Prototype Example
 Galaxy manufactures two toy doll
models:
– Space Ray.
– Zapper.
 Resources are limited to
– 1000 pounds of special plastic.
– 40 hours of production time per week.
6
 The Galaxy Industries Production
Problem –
A Prototype Example
 Marketing requirement
– Total production cannot exceed 700 dozens.
– Number of dozens of Space Rays cannot exceed
number of dozens of Zappers by more than 350.

• Technological input
– Space Rays requires 2 pounds of plastic and
3 minutes of labor per dozen.
– Zappers requires 1 pound of plastic and
4 minutes of labor per dozen.
7
 The Galaxy Industries Production
Problem –
A Prototype Example
 The current production plan calls for:
– Producing as much as possible of the more profitable product,
Space Ray ($8 profit per dozen).
– Use resources left over to produce Zappers ($5 profit
per dozen), while remaining within the marketing guidelines.

• The current production plan consists of:

Space Rays = 450 dozen 8(450) + 5(100)
Zapper = 100 dozen
Profit = $4100 per week
8
A linear programming model
can provide an insight and an
intelligent solution to this problem.

9
The Galaxy Linear Programming Model

 Decisions variables:
– X1 = Weekly production level of Space Rays
(in dozens)
– X2 = Weekly production level of Zappers (in
dozens).

 Objective Function:
– Weekly profit, to be maximized 10
The Galaxy Linear Programming Model

Max 8X1 + 5X2 (Weekly profit)

subject to
2X1 + 1X2 £ 1000 (Plastic)
3X1 + 4X2 £ 2400 (Production Time)
X1 + X2 £ 700 (Total production)
X1 - X2 £ 350 (Mix)
Xj> = 0, j = 1,2 (Nonnegativity)
11
The Graphical Analysis of Linear
Programming

The set of all points that satisfy

all the constraints of the model
is called a

FEASIBLE REGION

12
Using a graphical presentation
we can represent all the constraints,
the objective function, and the three
types of feasible points.

13
Graphical Analysis – the Feasible
Region
X2

The non-negativity constraints

X1

14
 Graphical Analysis – the Feasible
Region
X2

1000 The Plastic constraint

2X1+X2 £ 1000
700 Total production constraint:
X1+X2 £ 700 (redundant)
500

Infeasible
Production Feasible
Time
3X1+4X2 £ 2400 X1
500 700

15
 Graphical Analysis – the Feasible
Region
X2
1000 The Plastic constraint
2X1+X2 £ 1000
700 Total production constraint:
X1+X2 £ 700 (redundant)
500
Infeasible
Production mix
constraint:
Production Feasible X1-X2 £ 350
Time
3X1+4X2£ 2400
X1
500 700
Boundary points.
Interior points. Extreme points.
• There are three types of feasible 16
Solving Graphically for an
Optimal Solution

17
The search for an optimal solution

Start
X2 at some arbitrary profit, say profit = $2,000...
1000 Then increase the profit, if possible...
...and continue until it becomes infeasible

700 Profit =$4360

500

X1
18
500
 Summary of the optimal solution
Space Rays = 320 dozen
Zappers = 360 dozen
Profit = $4360
– This solution utilizes all the plastic and all the
production hours.

– Total production is only 680 (not 700).

– Space Rays production exceeds Zappers production

by only 40 dozens.
19
Extreme points and optimal solutions

– If a linear programming problem has an

optimal solution, an extreme point is
optimal.

20
 Multiple optimal solutions
• For multiple optimal solutions to exist, the
objective function must be parallel to one of
the constraints
• Any weighted average of
optimal solutions is also
an optimal solution.

21
 2.4 The Role of Sensitivity
Analysis of the Optimal
 Is the optimalSolution
solution sensitive to changes in
input parameters?

 Possible reasons for asking this question:

– Parameter values used were only best estimates.
– Dynamic environment may cause changes.
– “What-if” analysis may provide economical and
operational information.

22
 Sensitivity Analysis of
Objective Function Coefficients.
 Range of Optimality
– The optimal solution will remain unchanged as long as
 An objective function coefficient lies within its range of
optimality
 There are no changes in any other input parameters.

– The value of the objective function will change if the

coefficient multiplies a variable whose value is

nonzero.
23
 Sensitivity Analysis of
Objective Function Coefficients.
1000 X2

M
Ma ax
x 3 4X
.75 1 +
X 5X
M

1 +
ax

5X 2
8X

2
1
+

500
5X

Max
2

2X
1 + 5X
2

X1
24
500 800
 Sensitivity Analysis of
Objective
X
Function Coefficients.
1000 2
M
ax
8X

Range of optimality: [3.75, 10]

1
+
5X

Ma
2

x
10

500
Ma
X1

x3
.75
+5

X
+5
X2

1
X
2

25
400 600 800 X1
 Reduced cost
Assuming there are no other changes to the input
parameters, the reduced cost for a variable Xj that
has a value of “0” at the optimal solution is:
– The negative of the objective coefficient increase of
the variable Xj (-DCj) necessary for the variable to
be positive in the optimal solution
– Alternatively, it is the change in the objective value
per unit increase of Xj.
 Complementary slackness
At the optimal solution, either the value of a variable
is zero, or its reduced cost is 0.
26
 Sensitivity Analysis of
Right-Hand Side Values

 In sensitivity analysis of right-hand sides of

constraints we are interested in the following
questions:
– Keeping all other factors the same, how much
would the optimal value of the objective function
(for example, the profit) change if the right-hand
side of a constraint changed by one unit?
– For how many additional or fewer units will this per
unit change be valid?
27
 Sensitivity Analysis of
Right-Hand Side Values
 Any change to the right hand side of a
binding constraint will change the
optimal solution.

 Any change to the right-hand side of a

non-binding constraint that is less than
its slack or surplus, will cause no
change in the optimal solution.
28
 Shadow Prices

 Assuming there are no other changes to

the input parameters, the change to the
objective function value per unit increase
to a right hand side of a constraint is called
the “Shadow Price”

29
 Shadow Price – graphical
demonstration
The Plastic
constraint X2
When more plastic becomes
available (the plastic constraint is
relaxed), the right hand side of the
1000
plastic constraint increases.
2X 1

Maximum profit =
2X 1

+1
+1

$4360
x2
x2

<=

Maximum profit =
<=

10

500
10

01

$4363.4
00

Shadow price =
4363.40 – 4360.00 =
3.40
Production time X1
constraint
500 30
 Range of Feasibility

 Assuming there are no other changes to

the input parameters, the range of
feasibility is
– The range of values for a right hand side of a
constraint, in which the shadow prices for the
constraints remain unchanged.
– In the range of feasibility the objective function value
changes as follows:
Change in objective value =
[Shadow price][Change in the right hand side
value]
31
The Plastic
Range of Feasibility
constraint 2X 1 X2

Increasing the amount of

+1

1000 plastic is only effective

x2

until a new constraint

<=

becomes active.
10

Production mix A new active

00

constraint constraint
X1 + X2 £ 700
500
This is an infeasible solution
Production time
constraint

X1

500 32
The Plastic
Range of Feasibility
constraint 2X 1 X2

Note how the profit

+1

1000
increases as the amount
x2
£1

of plastic increases.
00
0

500

Production time
constraint

X1

500 33
 Range of Feasibility
X2

Less plastic becomes

1000 available (the plastic constraint
Infeasible is more restrictive).
solution The profit decreases

500
2X1 + 1X2 £ 1100

A new active
constraint
X1

500 34
The correct interpretation of shadow
prices
– Sunk costs: The shadow price is the
value of an extra unit of the resource, since
the cost of the resource is not included in
the calculation of the objective function
coefficient.

– Included costs: The shadow price is the

premium value above the existing unit
value for the resource, since the cost of the
resource is included in the calculation of
the objective function coefficient. 35
 Other Post - Optimality Changes

 Addition of a constraint.
 Deletion of a constraint.
 Addition of a variable.
 Deletion of a variable.
 Changes in the left - hand side
coefficients. 36
 Infeasible Model

No point, simultaneously,
lies both above line 1 and
below lines 2 and 3
2
.

3 1 37
Solver – Infeasible Model

38
Unbounded solution
th
eO Ma
xim

bje
cti i ze
Th ve
ef Fu
nc
r e ea ti o
g s
io ibl n
n e

39
 Solver – An Alternate Optimal
Solution
 Solver does not alert the user to the
existence of alternate optimal solutions.
 Many times alternate optimal solutions
exist when the allowable increase or
allowable decrease is equal to zero.
 In these cases, we can find alternate
optimal solutions using Solver by the
following procedure:

40
 Solver – An Alternate Optimal

Solution
Observe that for some variable X the
j
Allowable increase = 0, or
Allowable decrease = 0.
 Add a constraint of the form:
Objective function = Current optimal value.
 If Allowable increase = 0, change the objective
to Maximize Xj
 If Allowable decrease = 0, change the objective
to Minimize Xj

41
Cost Minimization Diet Problem
• Mix two sea ration products: Texfoods,
Calration.
• Minimize the total cost of the mix.
• Meet the minimum requirements of
Vitamin A,
Vitamin D, and Iron.

42
 Cost Minimization Diet Problem
 Decision variables
– X1 (X2) -- The number of two-ounce portions of
Texfoods (Calration)
product used in a serving.
 The Model
Cost per 2 oz.
Minimize 0.60X1 + 0.50X2
Subject to
20X1 + 50X2 ³ 100 Vitamin A
% Vitamin A
provided per 2 oz. 25X1 + 25X2 ³ 100 Vitamin D
% required
50X1 + 10X2 ³ 100 Iron
X1, X2 ³ 0 43
The Diet Problem - Graphical solution
10
The Iron constraint

Feasible Region

Vitamin “D” constraint

Vitamin “A” constraint

44
2 4 5
 Cost Minimization Diet Problem
 Summary of the optimal solution
– Texfood product = 1.5 portions (= 3 ounces)
Calration product = 2.5 portions (= 5 ounces)

– Cost =$ 2.15 per serving.

– The minimum requirement for Vitamin D and iron are

met with no surplus.

– The mixture provides 155% of the requirement for

45
Vitamin A.
Computer Solution of Linear Programs
With Any Number of Decision Variables

 Linear programming software packages solve

large linear models.
 Most of the software packages use the
algebraic technique called the Simplex
algorithm.
 The input to any package includes:
– The objective function criterion (Max or Min).

– The type of each constraint:
, , .
– The actual coefficients for the problem.
46
 The Steps in Implementing an
LP Model in a Spreadsheet
1. Organize the data for the model on the
spreadsheet.
2. Reserve separate cells in the spreadsheet for
each decision variable in the model.
3. Create a formula in a cell in the spreadsheet
that corresponds to the objective function.
4. For each constraint, create a formula in a
separate cell in the spreadsheet that
corresponds to the left-hand side (LHS) of the
constraint.
Let’s Implement a Model for the

Blue Ridge Hot Tubs Example...

MAX: 350X1 + 300X2 } profit
S.T.: 1X1 + 1X2 <= 200} pumps
9X1 + 6X2 <= 1566 } labor
12X1 + 16X2 <= 2880 } tubing
X1, X2 >= 0 } nonnegativity
 How Solver Views the Model
 Objective cell - the cell in the spreadsheet
that represents the objective function
 Variable cells - the cells in the spreadsheet
representing the decision variables
 Constraint cells - the cells in the
spreadsheet representing the LHS
formulas on the constraints
Let’s go back to Excel and see
how “Solver” works...
 Goals For Spreadsheet Design
 Communication - A spreadsheet's primary business
purpose is communicating information to managers.
 Reliability - The output a spreadsheet generates
should be correct and consistent.
 Auditability - A manager should be able to retrace the
steps followed to generate the different outputs from the
model in order to understand and verify results.
 Modifiability - A well-designed spreadsheet should
be easy to change or enhance in order to meet dynamic
user requirements.
 Spreadsheet Design
Guidelines - I
 Organize the data, then build the model
around the data.
 Do not embed numeric constants in
formulas.
 Things which are logically related should
be physically related.
 Use formulas that can be copied.
 Column/rows totals should be close to the
columns/rows being totaled.
 Spreadsheet Design
Guidelines - II
 The English-reading eye scans left to right,
top to bottom.
 Use color, shading, borders and protection
to distinguish changeable parameters from
other model elements.
 Use text boxes and cell notes to document
various elements of the model.
 Make vs. Buy Decisions:
The Electro-Poly Corporation
 Electro-Poly is a leading maker of slip-rings.
 A $750,000 order has just been received.
Model 1 Model 2 Model 3
Number ordered 3,000 2,000 900
Hours of wiring/unit 2 1.5 3
Hours of harnessing/unit 1 2 1
Cost to Make $50 $83 $130
Cost to Buy $61 $97 $145

 The company has 10,000 hours of wiring

capacity and 5,000 hours of harnessing
capacity.
Defining the Decision Variables

M1 = Number of model 1 slip rings to make in-

house
M2 = Number of model 2 slip rings to make in-
house
M3 = Number of model 3 slip rings to make in-
house
B1 = Number of model 1 slip rings to buy from
competitor
B2 = Number of model 2 slip rings to buy from
competitor
 Defining the Objective Function
Minimize the total cost of filling the
order.
MIN: 50M1+ 83M2+ 130M3+ 61B1+ 97B2+
145B3
 Defining the Constraints
 Demand Constraints
M1 + B1 = 3,000 } model 1
M2 + B2 = 2,000 } model 2
M 3 + B3 = 900 } model 3
 Resource Constraints
2M1 + 1.5M2 + 3M3 <= 10,000 } wiring
1M1 + 2.0M2 + 1M3 <= 5,000 } harnessing
 Nonnegativity Conditions
M1, M2, M3, B1, B2, B3 >= 0
 An Investment Problem:
Retirement Planning Services, Inc.
 A client wishes to invest $750,000 in the
following bonds.
Years to
Company Return Maturity Rating
Acme Chemical 8.65% 11 1-Excellent
DynaStar 9.50% 10 3-Good
Eagle Vision 10.00% 6 4-Fair
Micro Modeling 8.75% 10 1-Excellent
OptiPro 9.25% 7 3-Good
Sabre Systems 9.00% 13 2-Very Good
 Investment Restrictions
 No more than 25% can be invested in any
single company.
 At least 50% should be invested in long-
term bonds (maturing in 10+ years).
 No more than 35% can be invested in
DynaStar, Eagle Vision, and OptiPro.
Defining the Decision Variables

X1 = amount of money to invest in Acme

Chemical
X2 = amount of money to invest in DynaStar
X3 = amount of money to invest in Eagle
Vision
X4 = amount of money to invest in
MicroModeling
X5 = amount of money to invest in OptiPro
Defining the Objective Function
Maximize the total
annual investment return:

MAX: .0865X1+ .095X2+ .10X3+ .0875X4+ .0925X5+ .

09X6
 Defining the Constraints
 Total amount is invested
X1 + X2 + X3 + X4 + X5 + X6 = 750,000
 No more than 25% in any one investment
Xi <= 187,500, for all i
 50% long term investment restriction.
X1 + X2 + X4 + X6 >= 375,000
 35% Restriction on DynaStar, Eagle Vision, and
OptiPro.
X2 + X3 + X5 <= 262,500
 Nonnegativity conditions
Xi >= 0 for all i
 A Transportation Problem:
Tropicsun
Processing
Groves Distances (in miles) Plants
Supply Capacity
Mt. Dora 21 Ocala
275,000 200,000
1 50 4

40

35
Eustis 30 Orlando
400,000 600,000
2 5
22

55

Clermont 20 Leesburg
300,000 225,000
3 25 6
 Defining the Decision
Variables
Xij = # of bushels shipped from node i to node j
Specifically, the nine decision variables are:

X14 = # of bushels shipped from Mt. Dora (node 1) to Ocala

(node 4)
X15 = # of bushels shipped from Mt. Dora (node 1) to Orlando
(node 5)
X16 = # of bushels shipped from Mt. Dora (node 1) to Leesburg
(node 6)
X24 = # of bushels shipped from Eustis (node 2) to Ocala (node
4)
X25 = # of bushels shipped from Eustis (node 2) to Orlando
(node 5)
Defining the Objective Function

Minimize the total number of bushel-

miles.
MIN: 21X14 + 50X15 + 40X16 +
35X24 + 30X25 + 22X26 +
55X34 + 20X35 + 25X36
 Defining the Constraints
 Capacity constraints
X14 + X24 + X34 <= 200,000 } Ocala
X15 + X25 + X35 <= 600,000 } Orlando
X16 + X26 + X36 <= 225,000 } Leesburg
 Supply constraints
X14 + X15 + X16 = 275,000 } Mt. Dora
X24 + X25 + X26 = 400,000 } Eustis
X34 + X35 + X36 = 300,000 } Clermont
 Nonnegativity conditions
Xij >= 0 for all i and j
Implementing the Model
See file Fig3-26.xlsm
 A Blending Problem:
The Agri-Pro Company
 Agri-Pro has received an order for 8,000 pounds of
chicken feed to be mixed from the following feeds.
Percent of Nutrient in
Nutrient Feed 1 Feed 2 Feed 3 Feed 4
Corn 30% 5% 20% 10%
Grain 10% 3% 15% 10%
Minerals 20% 20% 20% 30%
Cost per pound $0.25 $0.30 $0.32 $0.15

 The order must contain at least 20% corn,

15% grain, and 15% minerals.
Defining the Decision Variables

X1 = pounds of feed 1 to use in the

mix
X2 = pounds of feed 2 to use in the
mix
X3 = pounds of feed 3 to use in the
mix
X4 = pounds of feed 4 to use in the
mix
Defining the Objective Function

Minimize the total cost of filling the

order.

MIN: 0.25X1 + 0.30X2 + 0.32X3 +

0.15X4
 Defining the Constraints
 Produce 8,000 pounds of feed
X1 + X2 + X3 + X4 = 8,000
 Mix consists of at least 20% corn
(0.3X1 + 0.5X2 + 0.2X3 + 0.1X4)/8000 >= 0.2
 Mix consists of at least 15% grain
(0.1X1 + 0.3X2 + 0.15X3 + 0.1X4)/8000 >= 0.15
 Mix consists of at least 15% minerals
(0.2X1 + 0.2X2 + 0.2X3 + 0.3X4)/8000 >= 0.15
 Nonnegativity conditions
X1, X2, X3, X4 >= 0
 A Comment About Scaling
 Notice the coefficient for X2 in the ‘corn’
constraint is 0.05/8000 = 0.00000625
 As Solver runs, intermediate calculations are
made that make coefficients larger or smaller.
 Storage problems may force the computer to
use approximations of the actual numbers.
 Such ‘scaling’ problems sometimes prevents
Solver from being able to solve the problem
accurately.
 Most problems can be formulated in a way to
minimize scaling errors...
 Re-Defining the Decision
Variables
X1 = thousands of pounds of feed 1 to use in
the mix
X2 = thousands of pounds of feed 2 to use in
the mix
X3 = thousands of pounds of feed 3 to use in
the mix
X4 = thousands of pounds of feed 4 to use in
the mix
 Re-Defining the
Objective Function
Minimize the total cost of filling the
order.

MIN: 250X1 + 300X2 + 320X3 +

150X4
 Re-Defining the Constraints
 Produce 8,000 pounds of feed
X1 + X2 + X3 + X4 = 8
 Mix consists of at least 20% corn
(0.3X1 + 0.5X2 + 0.2X3 + 0.1X4)/8 >= 0.2
 Mix consists of at least 15% grain
(0.1X1 + 0.3X2 + 0.15X3 + 0.1X4)/8 >= 0.15
 Mix consists of at least 15% minerals
(0.2X1 + 0.2X2 + 0.2X3 + 0.3X4)/8 >= 0.15
 Nonnegativity conditions
X1, X2, X3, X4 >= 0
 Scaling: Before and After
 Before:
– Largest constraint coefficient was 8,000
– Smallest constraint coefficient was
0.05/8 = 0.00000625.
 After:
– Largest constraint coefficient is 8
– Smallest constraint coefficient is
0.05/8 = 0.00625.
 The problem is now more evenly scaled!
Implementing the Model
See file Fig3-30.xlsm
 A Production Planning Problem:
The Upton Corporation
 Upton is planning the production of their heavy-duty air
compressors for the next 6 months.
Month
1 2 3 4 5 6
Unit Production Cost $240 $250 $265 $285 $280 $260
Units Demanded 1,000 4,500 6,000 5,500 3,500 4,000
Maximum Production 4,000 3,500 4,000 4,500 4,000 3,500
Minimum Production 2,000 1,750 2,000 2,250 2,000 1,750

• Beginning inventory = 2,750 units

• Safety stock = 1,500 units
• Unit carrying cost = 1.5% of unit production
cost
• Maximum warehouse capacity = 6,000 units
 Defining the Decision Variables
Pi = number of units to produce in month i, i=1
to 6

Bi = beginning inventory month i, i=1 to 6

 Defining the Objective Function
Minimize the total cost production
& inventory costs.

MIN:
240P1+250P2+265P3+285P4+280P5+260
P6
+ 3.6(B1+B2)/2 + 3.75(B2+B3)/2 +
3.98(B
Note: 3+B4)/2 inventory in any month is
The beginning
the same as the ending inventory in the
+ 4.28(Bmonth.
previous 4+B5)/2 + 4.20(B5+ B6)/2 +
3.9(B +B )/2
 Defining the Constraints - I
 Production levels
2,000 <= P1 <= 4,000 } month 1
1,750 <= P2 <= 3,500 } month 2
2,000 <= P3 <= 4,000 } month 3
2,250 <= P4 <= 4,500 } month 4
2,000 <= P5 <= 4,000 } month 5
1,750 <= P6 <= 3,500 } month 6
 Defining the Constraints - II
 Ending Inventory (EI = BI + P - D)
1,500 < B1 + P1 - 1,000 < 6,000 } month 1
1,500 < B2 + P2 - 4,500 < 6,000 } month 2
1,500 < B3 + P3 - 6,000 < 6,000 } month 3
1,500 < B4 + P4 - 5,500 < 6,000 } month 4
1,500 < B5 + P5 - 3,500 < 6,000 } month 5
1,500 < B6 + P6 - 4,000 < 6,000 } month 6
 Defining the Constraints - III
 Beginning Balances
B1 = 2750
Notice that the
B2 = B1 + P1 - 1,000 Bi can be
B3 = B2 + P2 - 4,500 computed
directly from
B4 = B3 + P3 - 6,000 the Pi.
Therefore, only
B5 = B4 + P4 - 5,500 the Pi need to
B6 = B5 + P5 - 3,500 be identified
as changing
B7 = B6 + P6 - 4,000 cells.
Implementing the Model
See file Fig3-33.xlsm
 A Multi-Period Cash Flow
Problem:
The Taco-Viva Sinking Fund - I
 Taco-Viva needs a sinking fund to pay $800,000 in
building costs for a new restaurant in the next 6 months.
 Payments of $250,000 are due at the end of months 2
and 4, and a final payment of $300,000 is due at the end
of month 6.
 The following investments may be used.
Investment Available in Month Months to Maturity Yield at Maturity
A 1, 2, 3, 4, 5, 6 1 1.8%
B 1, 3, 5 2 3.5%
C 1, 4 3 5.8%
D 1 6 11.0%
 Summary of Possible Cash Flows
Cash Inflow/Outflow at the Beginning of Month
Investment 1 2 3 4 5 6 7
A1 -1 1.018
B1 -1 <_____> 1.035
C1 -1 <_____> <_____> 1.058
D1 -1 <_____> <_____> <_____> <_____> <_____> 1.11
A2 -1 1.018
A3 -1 1.018
B3 -1 <_____> 1.035
A4 -1 1.018
C4 -1 <_____> <_____> 1.058
A5 -1 1.018
B5 -1 <_____> 1.035
A6 -1 1.018
Req’d Payments $0 $0 $250 $0 $250 $0 $300
 Defining the Decision Variables
Ai = amount (in $1,000s) placed in investment
A at the beginning of month i=1, 2, 3, 4, 5,
6
Bi = amount (in $1,000s) placed in investment
B at the beginning of month i=1, 3, 5
Ci = amount (in $1,000s) placed in investment
C at the beginning of month i=1, 4
Di = amount (in $1,000s) placed in investment
D at the beginning of month i=1
 Defining the Objective Function

Minimize the total cash invested in month

1.

MIN: A1 + B1 + C1 + D1
 Defining the Constraints
 Cash Flow Constraints
1.018A1 – 1A2 = 0 } month 2
1.035B1 + 1.018A2 – 1A3 – 1B3 = 250 } month 3
1.058C1 + 1.018A3 – 1A4 – 1C4 = 0 } month 4
1.035B3 + 1.018A4 – 1A5 – 1B5 = 250 } month 5
1.018A5 –1A6 = 0 } month 6
1.11D1 + 1.058C4 + 1.035B5 + 1.018A6 = 300 } month 7
 Nonnegativity Conditions
Ai, Bi, Ci, Di >= 0, for all i
Implementing the Model
See file Fig3-37.xlsm
 Risk Management:
The Taco-Viva Sinking Fund - II
 Assume the CFO has assigned the following risk ratings to
each investment on a scale from 1 to 10 (10 = max risk)

Investment Risk Rating

A 1
B 3
C 8
D 6
 The CFO wants the weighted average risk to not
exceed 5.
 Defining the Constraints
 Risk Constraints
1A1 + 3B1 + 8C1 + 6D1
A1 + B 1 + C 1 + D 1
<5 } month 1

1A2 + 3B1 + 8C1 + 6D1

A2 + B 1 + C 1 + D 1
<5 } month 2

1A3 + 3B3 + 8C1 + 6D1

<5 } month 3
A3 + B 3 + C 1 + D 1

1A4 + 3B3 + 8C4 + 6D1

<5 } month 4
A4 + B 3 + C 4 + D 1

1A5 + 3B5 + 8C4 + 6D1

<5 } month 5
A5 + B 5 + C 4 + D 1

1A6 + 3B5 + 8C4 + 6D1

<5 } month 6
A6 + B 5 + C 4 + D 1
 An Alternate Version of
the Risk Constraints
 Equivalent Risk Constraints

-4A1 – 2B1 + 3C1 + 1D1 < 0 } month 1

-2B1 + 3C1 + 1D1 – 4A2 < 0 } month 2 Note that each

coefficient is
3C1 + 1D1 – 4A3 – 2B3 < 0 } month 3 equal to the risk
factor for the
1D1 – 2B3 – 4A4 + 3C4 < 0 } month 4 investment
minus 5 (the
1D1 + 3C4 – 4A5 – 2B5 < 0 } month 5 max. allowable
weighted
1D1 + 3C4 – 2B5 – 4A6 < 0 } month 6 average risk).
Implementing the Model
See file Fig3-40.xlsm
 Data Envelopment Analysis (DEA):
Steak & Burger
 Steak & Burger needs to evaluate the performance
(efficiency) of 12 units.
 Outputs for each unit (Oij) include measures of: Profit,
Customer Satisfaction, and Cleanliness
 Inputs for each unit (Iij) include: Labor Hours, and Operating
Costs
 The “Efficiency” of unit i is defined as follows:
nO

Weighted sum of unit i’s outputs  Oij w j

j 1
= nI
Weighted sum of unit i’s inputs
 I ij v j
j 1
Defining the Decision Variables
wj = weight assigned to output j
vj = weight assigned to input j

A separate LP is solved for each unit, allowing

each unit to select the best possible weights for
itself.
 Defining the Objective Function

Maximize the weighted output for unit i :

nO
MAX:  Oij w j
j 1
 Defining the Constraints
 Efficiency cannot exceed 100% for any unit
nO nI
 Okj w j   I kj v j , k 1 to the number of units
j 1 j 1

 Sum of weighted inputs for unit i must equal 1

nI
 I ij v j 1
j 1

 Nonnegativity Conditions
wj, vj >= 0, for all j
 Important Point

When using DEA, output variables should be

expressed on a scale where “more is better”
and input variables should be expressed on a
scale where “less is better”.
Implementing the Model
See file Fig3-43.xlsm
 Psi Functions
 Risk Solver Platform includes a number of
custom functions that all begin with the letters
“Psi” (short for polymorphic spreadsheet
interpreter)
 When running multiple optimizations:
– PsiCurrentOpt( ) returns the integer index of the
current optimization
– PsiOptValue(cell, opt #) returns the optimal
value of the indicated cell for a particular
optimization (opt #)
Analyzing The Solution
See file Fig3-48.xlsm
End of Lecture