Quantitative Methods Assignment

2011
FACULTY OF MANAGEMENT STUDIES
University of Delhi

Linear Programming Applications in Selection of Projects/ Fund allocation in projects

Submitted by:

INDEX
1. 2. 3. 4. 5. 6. Problem Statement 3 Solution..4 Theory on the Problem Statement Snapshot of the Excel Solver Project Selection Solution References.

Problem Statement
Problem
An organization has a certain set of projects(project1.project5). Each project has a certain amount of cash outflow (expenditures) and cash inflow (revenue).The problem is, given the constraint budget allocation for few years, find the optimal solution for maximizing the profit given the Net Present Value(NPV) for each project. Any project may or may not be selected. The cumulative expenditure on all the selected projects by the company for the first year and second year should not be more than 40 crores and 25 crores respectively. Following table is the list of the projects with their respective NPVs and cash outflows in 2 years.

S.No.

PROJECT

NET PRESENT VALUE ( NPV ) (in crores) 16 19 15 16 35

EXPENDITURE or CASH OUTFLOW IN PERIOD 1 (in crores) 15 45 10 12 20

EXPENDITURE or CASH OUTFLOW IN PERIOD 2 (in crores) 10 14 12 4 25

1 2 3 4 5

Project 1 Project 2 Project 3 Project 4 Project 5

Solution:

NPV

16

19

15

16

35

X1

X2

X3

X4

X5

CASH 1

15

45

10

12

20

CASH 2

10

14

12

25

Theory on Problem Statement

We have used Microsoft Excel Solver for solving the problem. We need to formulate the following linear programming problem: 1. Decision Variables 2. Objective Function 3. Constraints

Assumptions
The following assumptions are made:1. Linearity: - It is assumed that the affect of the decision variables will be linear on the constraints and objective function. Otherwise, the Excel Solver will not give the correct answers. 2. Certainty: - Values of parameters are known and certain even though they are likely to change over period of time. 3. Non-negativity: - Only non-negative values are acceptable. In our case, it is restricted to a. 0 or 1.
4. Negative values are not considered. For any project, the possibility of negative returns is ignored.

5. Values will remain constant. This might not be true since the values of revenues and costs vary with time. But considering a block of time frame, the values differ only slightly

Decision Variables
In our case, the decision variables will be whether the project has been selected or not. There are 5 projects which mean there are 5 decision variables. The decision variables are namely X1, X2, X3, X4 and X5.

Objective Function

The objective of the organization is to maximize the profit. Assuming revenue will be the same as the NPV, the objective function becomes Maximize Z = (NPVi * Xi) And Xi = 0 or 1
OBJECTIVE FUNCTION: MAX Z= 16X1 + 19 X2 + 15 x3 + 16 X4 + 35 X5

where i=1,2,3,4,5

Constraints
Weve been given maximum expenditure that can be invested overall in all the projects over the period of two years. The expenditures (cash outflows) are E1 and E2 for the first and second year respectively. The cash outflows for all the projects are known over the period. Let the cash outflow be Cij for year i and project j respectively. The row in the Excel is represented as CASH1 and CASH2 for the two years.

Then, the constraint for any year is Cij * Xj Ei

CONSTRAINT FUNCTION: 15 X1 + 45 X2 + 10 X3 + 12 X4 + 20 X5 <= 40 10 X1 + 14 X2 + 12 X3 + 4 X4 + 25 X5 <= 25 0<= Xj <= 1 WHERE J= 1,2,3,4,5

EXCEL SOLVER SNAPSHOT

Project Selection Solution

The solution we get using the excel solver. SLACK VALUE

Slack Value refers to the value we get when the optimal solution is put into a less than or equal to equation and the resulting value is less than the right hand side constraint. The optimal solution should give slack because the constraint is to reduce the cost as much as possible. Using the Excel solver, we have also found out the slack values for each of the project. All the projects which have slack value as 0 are binding because the constraint restricts the possible changes of the point while any positive value is not binding.

Plz mention the slack value in the constraint equation

References