Management

Science


Section
G5

Group
4
CASE PROBLEM 1
(APPLICATIONS OF LINEAR PROGRAMMING)
DARREN NEO JUN WEI
LOH ZHIQIANG BENJAMIN
SHERLY CENDANA KOALITAS
PERRY WONG WEI LIANG
TAN WEE KEAT JOHN
Page 1 of 14

Introduction

Problem: Due to unexpected expenditures, Susan could not balance her
checking accounts. Thus she had to resort to using her credit cards to pay her
bills and that landed her in debt due to the high interest charges incurred.

Given:
Left $3,800 to start the new year with
Expected monthly liabilities for the coming year
After taxes and benefits salary is $29,400/ year = $2450/month

Task:
To develop a budget to meet the demands of irregular monthly liabilities
and save some money
To plan how much money should be invested in the 1 month, 3 month, or
7 month short term investment vehicles with yield of 6%, 8% and 12%
per annum respectively
To maximize her investment returns

In this case, we have defined the objective function to be maximization of
investment return. As all the functions in this problem are linear, we have
adopted the Linear- Programming (LP) model.

a) Model Formulation

Decision Variables:
Let Ai be the amount invested in the 1-month investment plan for month i
Let Bi be the amount invested in the 3-month investment plan for month i
Let Ci be the amount invested in the 7-month investment plan for month i

Where i=1,2,3,4,5,6,7,8,9,10,11,12
1. January
2. February
3. March
4. April
5. May
6. June
7. July
8. August
9. September
10. October
11. November
12. December
Page 2 of 14

Objective Function:

Maximize Z = (0.06/12)(A1+A2+A3+A4+A5+A6+A7+A8+A9+A10+A11+A12) +
(0.08*3/12)(B1+B2+B3+B4+B5+B6+B7+B8+B9+B10+B11+B12) +
(0.12*7/12)(C1+C2+C3+C4+C5+C6+C7+C8+C9+C10+C11+C12)
Constraints:

Subject to:
3800+2450-A1-B1-C1=2750 [January]
o (Leftover cash from previous year + Salary Investments into A, B
or C = estimated bill for month 1)

2450+A1-A2-B2-C2=2860 [February]
o (Salary + investment principal from previous investments
investments into A, B or C = estimated bill for month 2)

2450+A2-A3-B3-C3=2335 [March]
o (Salary + investment principal from previous investments
investments into A, B or C = estimated bill for month 3)

2450+A3+B1-A4-B4-C4=2120 [April]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 4)

2450+A4+B2-A5-B5-C5=1205 [May]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 5)

2450+A5+B3-A6-B6-C6=1600 [June]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 6)

2450+A6+B4-A7-B7-C7=3050 [July]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 7)

2450+A7+B5+C1-A8-B8-C8=2300 [August]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 8)

2450+A8+B6+C2-A9-B9-C9=1975 [September]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 9)

2450+A9+B7+C3-A10-B10-C10=1670 [October]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 10)


Page 3 of 14


2450+A10+B8+C4-A11-B11-C11=2710 [November]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 11)

2450+A11+B9+C5-A12-B12-C12=2980 [December]
o (Salary + investment principals from previous investments
investments into A, B or C = estimated bill for month 12)


Using Excel


Screenshot of Model Formulation in Excel

















Page 4 of 14

Screenshot of Solver Parameters


The optimal returns on investments is

The maximum return on investments is: $844.60

Do note, the constraints are held at equality because it is stated in the case that
Susan will invest any money she doesnt use to meet her liabilities in the short
term investments.

Page 5 of 14


Answer Report

In the beginning, Susan has $3,800 outstanding left from the selling of her
condominium and every month, she will earn $2,450 from her monthly
paychecks. She has the option to invest in 3 different investments with a one
month, 3 months and 7 months maturity date.





Using the LP model which we have formulated as well as the constraints which
the model is subjected to, we have attained the conclusion that the maximum
return which she can obtain from the investments is $844.60.

Page 6 of 14


Page 7 of 14


The final value as shown in the table is the value of the optimized objective
function and it tells the best mix of the different investments which will produce
the highest returns as part of her budget.


The original value is set according to the current configuration so that one can
compare the original value and the final value to see by what amount the solver
improves the objective function value.


The constraints are binding because she uses the principal from each due short
term investment to reinvest in the following months investments which is part
of her budget.


Also, since any interest earned is directed to another long term investment, she
doesnt consider any excess amount above the monthly liabilities, therefore the
constraints are binding and equal to her monthly liabilities and the slacks will
hence be equal to 0.






Page 8 of 14

SENSITIVITY REPORT
Sensitivity range of the objective function coefficient



Objective Function: Max Z= 0.005(1-month investment) + 0.02 (3-month
investment) + 0.07 (7-month investment)

There is more than one optimal solution as there are no zeros in the allowable
increase or allowable decrease columns for the variables. This means that there
are multiple proposed investment schedule that Susan can use to maximise
investment returns, given its constraints. The solution we have obtained is
degenerate.

The sensitivity range for the objective coefficient is reflected above, where the
maximum is (objective function + allowable increase) and the minimum is
(objective coefficient - allowable decrease) which the current optimal solution
point will remain optimal.
Page 9 of 14

For instance in January, if the coefficient value for 1-month investment is 0.005
per annum is not increased and is decreased to infinity, the optimal investment
plan remains unchanged. It means that the interest rate for 1-month investment
plan varies from 0 to 0.005; considering that having negative interest rate is
unrealistic for any investment plan.

As reflected in the table, Susan can look for plans with higher returns for the 1-
month investment plan for certain months such as February and March without
changing the amount invested for each month.


Sensitivity Analysis for Constraints Quantity Value

In this portion of the report, we analyzed how changes to the RHS of the
constraints will affect the optimal solution. A change in the RHS of the
constraints will result in a change in the feasible region and hence the solution
mix will also be changed.

For our analysis, we will clearly define the sensitivity range whereby a change in
the constraint quantity value will not result in a change in the solution variable
mix.


Table from sensitivity report


We calculated the sensitivity ranges for the constraints from January to
December from the values shown in the table above. This table is part of the
sensitivity report generated by applying solver to our data and formulas. The
upper bound on the constraints is calculated by taking the RHS constraint plus
the allowable increase. The lower bound is calculated by taking the RHS
constraint plus allowable decrease.
Page 10 of 14





Name
Upper
Bound Lower Bound
January Flow ($) 5840

February Flow ($) 5950
2450
March Flow ($) 2450

April Flow ($) 5655

May Flow ($) 2450

June Flow ($) 1850

July Flow ($) 3300 2450
August Flow ($) 2450

September Flow ($) 2700

October Flow ($) 2450

November Flow ($) 6915

December Flow ($) 8625

Table of sensitivity ranges

The table above reflects the validity of the changes over a range of values for
Susans bills. As long as the RHS stays within the range, the shadow price is valid.
However as explained below, as the shadow price is not apply in this situation,
these values are of irrelevance.


Shadow Price

The shadow price is the marginal value of one additional unit of resource.

Therefore it indicates the degree of the change to the objective function when the
RHS constraint is changed. In this case our constraints are all binding. Also there
is no slack since the any amount leftover will be reinvested again (the final
values for every month is equal to the RHS constraint).

Hence since this is not a product mix model and instead an investment budgeting
model, shadow price does not apply in this situation and its negative value does
not affect the quality of the solution in any way.





Page 11 of 14

Recommendation
In conclusion, we recommend that Susan follow the following investment plan.
















This plan will allow Susan to yield a total profit of $ 844.60.

With reference to the sensitivity report for objective coefficient, we can deduce
that Susan will earn more profit looking for plans with higher returns for the 1-
month, 3-month and 7-month investment plan with the same amount invested in
each investment plan.

These results are made based on the assumptions:
1. Expected expenditure is constant
Currently, she is spending on large insurance premium, large credit card
bills and bills for a magazine subscription. However in this case, certain
bills are susceptible to changes in the economic environment such as
interest rate for insurance premium and credit card bills.

Previously, Susan pays bills with her bank credit card and pay off her
accumulated debt in installments while incurring high interest rates. Considering
that the expected expenditure is constant, she will not need to accumulate debt
and hence it allows her to not have any leverage.

We will recommend for Susan to reduce her discretionary expenditure such as
on magazine subscription. Last but not least, we will recommend for Susan not to
completely invest as she needs to have some cash flow for emergencies and not
lock in all her money in investment plans.





Page 12 of 14

b) How Much Does Susan Need to Develop a
Feasible Budget?

Considering if she does not have the $3800 to begin with, she will not be able to
pay her liabilities for the first 2 months. Thus, there will be no feasible solution if
she does not have the $3800 to begin with.




Therefore, she requires a minimum amount to at least pay off her estimated bills.
To calculate the minimum amount required, we would look at how much extra is
sufficient to pay her bills.

Looking at the table, only for the first 2 months the estimated bills are more than
the salary of $2450.

Therefore, the minimum amount she needs is:
($2750-2450) + (2860-2450) = $710

The available funds she should have at the start of Jan = $2450+710=$3160











Page 13 of 14


Plugging it back into the excel file,


The optimal returns on investments is:



The return on investments becomes: $334.75

























Page 14 of 14

CONCLUSION

To increase her investment returns, Susan could consider investing in bonds
with higher returns or she could also study the stock markets and exploit its high
returns.

Alternatively, Susan could also consider switching to another better paying job
or take up a part time job to increase her monthly income so that she will have a
higher disposable income to work with.

Also, with more income, Susan will be able to invest more of it and get higher
returns and ultimately increasing her overall investment returns.

Hence our group strongly feels that Susan should take another course of
Management Science as a refresher course under Professor Joyce Low as it will
equip her with all the tools necessary to better manager her own finances.

In conclusion, Susan should follow the model stated in either of the questions in
order better manage her finances and also increase her investment returns.