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Executive Summary

Shelby Shelving problem is to determine the monthly optimal product plan of the two types of shelves
(S and LX) that will optimally allocate the available capacity to maximize the total profit. In addition,
Sensitivity analysis also provide insights of how the total profit will change as we change some
selected inputs, i.e. the material cost and the selling price.

The key issue is to determine the optimal decision variables (units of production for each shelve
model) that will maximize our objective (total profit) and satisfy the resources constraints (assembly
capacity, available hours in stamping and forming units), and the use of Excel Solver to incorporate all
parameters to develop a linear programming (LP) model to optimize resource allocation such that the
total profit is maximized.

The total profit is the sum of each product profit less the fixed cost. The total cost consists of fixed and
variable costs. The variable costs include the direct materials, the direct labor, and the overhead cost
per unit of production. On the other hand, the fixed cost is monthly constant cost and unvaried with the
unit of production. The fixed cost includes the cost from the stamping, forming, and assembly process.
The contribution margin is the selling price less the variable cost. The solution is to draw the optimal
decision for product mix plan to maximize the profit under the constraint of limited resources. From
information on pricing, cost calculation, limited resources and process analysis; the calculation has
proven that the contribution margin of model S is higher than model LX. As a result, to optimize the
production mix, all resources should be allocated to produce model S up to its maximum production
capacity, and to allocate the left over resources to produce model LX respectively.

Model

• Decision: Monthly production units of each model (S and LX)


• Objective: Maximize total profit with limited company resources
• Assumptions:
– The problem has the properties of linear models: proportionality, additivity, and divisibility.
– The decision variables (quantities of each product) are non-negative.
– All produced shelves can be sold.
– The shelf manufacturing starts from stamping step, then forming, then assembly step.
– Maximum capacity of machine for stamping and forming are 800 hours/month
– Assembly capacity for Model S and Model LX are 1900 and 1400 units/month

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– Selling price for Model S and Model LX are $1,800 and $2,100/unit and constant because of
the competition
• Structure:
– Total Fixed Cost ($) = sum of the Fixed Cost from S Model, and Assembly LX Model
– Overhead cost ($/set) = sum of the Overhead cost from Stamping, Forming, and Assembly
– Direct labor cost ($/set)= sum of the Direct Labor cost from Stamping, Forming, and Assembly
– Variable cost ($/set) = sum of the Direct Material cost, Overhead cost, and Labor costs
– Contribution Margin ($/set) = Selling price($/set) – Variable cost ($/set)
– Total profit ($) = sum of each model (Contribution margin * Quantity) - Fixed cost
– Total resource time required (hrs, each process) = sum of each model of machine time
requirement (hours/set) * quantities
– Excess Capacity = Available Resources - Utilized Resources

Analysis on the algebraic model:


Before getting to the analysis on the use of Excel Solver, we expressed the problem by algebraic model
to understand the logic of all steps required in calculations. It will also help us to correctly setup the LP
model in the Excel Solver which follows the same logic stated below.
Let x1 and x2 represent the numbers of Model S and LX respectively. The algebraic model is
as follows:
Maximize 260x1 + 245x2 – 385,000 (profit objective)
Subject to
0.3x1 + 0.3x2 <= 800 (stamping machine constraint)
0.25x1 + 0.5x2 <= 800 (forming machine constraint)
x1 <= 1900 (assembly capacity constraint)
x2 <= 1400 (assembly capacity constraint)
x1, x2 >= 0 (non-negativity constraints)

Analysis on the spreadsheet model:


– Excel’s add-in solver is used to determine the production mix that yields the maximum profit
given limited resources. The elements required in running the solver are set as follows;
○ Inputs are all numerical data in the problem. They are colored in blue fonts.
○ The changing cells (decision variables) in blue boxes are the number of units of Model
S and LX.
○ The target cell (objective) in green box is the total profit that to be maximized

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○ The constraints are the limited resource capacities which impose restrictions on the
values in changing cells. The constraints are the assembly capacity dedicated to each
model and the shared available hours in stamping and forming units. The red boxes
indicate the constraint limits while the yellow boxes are the calculated outcomes that are
constrained by the constraint limits.
– Sensitivity analysis can be done by generating the Sensitivity Report from the Solver add-in
or by re-run the model with manually vary the selected inputs.
○ The optimal product mix plan will not change if the change in contribution margin is
within the allowable increase and decrease range shown in Table 2, Exhibit 1C:
Sensitivity Report
○ The incremental profit will be increased by the amount of the reduced cost if we allow
the bottleneck resource to be relaxed by one unit.
○ The shadow price shows the change in profit if the final value (hrs spent) is relaxed by
one unit. The limit of the relaxed range before changing the original optimal time spent is
the allowable increase and decrease.

Conclusion

Answer (a): In order to maximize the total profit, the production plan should be 1,900 units of
Model S and 650 units of Model LX .The corresponding monthly profit would be $268,250 (Exhibit
1A and 1B). Table 1 shows the optimal resources allocation and the excess capacity of the three
processes.

Table1. Resources allocation at the optimal production mix


Resources Allocation
Capa- Total Excess
Resources Spent Spent
city Resources Capacity
on Model S on Model LX Spent

Stamping (hrs) 800 570 hrs 195 hrs 765 hrs 35 hrs

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Forming (hrs) 800 475 hrs 325 hrs 800 hrs -

Assembly Model S (sets) 1900 1900 sets - 1900 sets -

Assembly Model LX (sets) 1400 - 650 sets 650 sets 750 sets

Interpretation: Since the contribution margin of Model S ($260/set) is higher than Model LX ($245/set),
we would want to maximize production of Model S as much as possible to maximize the total profit
which is align with the result in Exhibit 1C showing the allowable increase in producing Model S is
infinity.

Since the forming and the assembly of model S has no excess capacity left, these two processes show
potential to be the bottlenecking steps to increase the production and profit. In fact, the forming step is
the key bottleneck since it occurs prior to the assembly step. If we would like to debottleneck the plant
to generate more profit, the forming department is first considered.

From table 3: sensitivity table in Exhibit 1C, if we increase the constraint limit of the forming process
from 800 to 801 hours, the total profit will be increased from $268,250 to $268,740 ($490 incremental
profit). This resulted from the increase in Model LX production from 650 to 652 units times its
contribution margin (2 sets* $245/set = $490).

Answer (b): Company should invest $200/hr to increase the time limit in the forming department
(current limit 800 hours), however company should not increase the limit more than 58.33 hours.

Interpretation: From Exhibit 1B, the bottleneck departments are Forming and Assembly for Model S
departments as their slack (excess capacity) = 0. Given that we can increase capacity in only one
department, we should invest at the forming step since the forming process is required prior to the
assembly.

From table 3 Exhibit 1C, the shadow price of Stamping step is zero indicated that there is no benefit
by increasing its capacity (hours). However, the total profit will be increased by $490 on every increase
in capacity hour in the forming department (the shadow price of forming) which is higher than the
investment of $200/hr. However, the increase in forming constrained hours should not exceed the
allowable increase of 58.33 hours. If the forming constraint is increased to be higher than 58.33 hours,
the forming hours will be leftover and the stamping department will become bottleneck instead.
Therefore, the additional investment in the forming step will no longer resolve the bottlenecking issue.

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Answer (c): If the material cost of Model S increases by $100/set, the production plan will still be the
same (Model S =1900 units and Model LX =650 units). However, the total monthly profit will decrease
be decreased from $268,250 to $78,250.

Interpretation: The increase in Model S material cost of $100/set will directly reduce the Model S
contribution margin from $260/unit to $160/unit. In other words, contribution margin is $100 decreased.

– From the Sensitivity Report (Exhibit 1C), we can observe from Exhibit 1C table 2 that the
allowable decrease on the Model S objective coefficient (contribution margin) is $137.5/set.
Since the decrease of $100/set is still within the allowable range, the optimal production plan
will not be changed. We can calculate the monthly total profit as (160 X 1900) + (245 X 650) –
385,000 = $78,250.
– From Exhibit 2A, by re-run the Solver model with the new input of Model S direct material cost
$1,100/set, we also found the maximum profit of $78,250 with the same production mix.

Answer (d): If we can increase the selling price of Model LX $2,100 to $2,400, the monthly production
plan will change to be Model S = 400 units and Model LX = 1,400 units. The total monthly profit will
increase from $268,250 to $482,000.

Interpretation: The increase in Model LX price of $300/set ($2,400-$2,100) will directly increase its
contribution margin by $300/set (from $245/unit to $545/unit). With this change, we would want to
maximize Model LX production because of its higher contribution margin.

– From the Sensitivity Report (Exhibit 1C), we can observe from table 2 that the allowable
increase on the Model LX objective coefficient (contribution margin) is $275/set. Since the new
contribution margin increase of $300/set is higher than the allowable increase, the optimal
production plan will be changed. It is required to rerun the Solver model with the new input
of Model LX selling price $2,400/set. All constraints, fixed cost, and the contribution margin of
Model S ($260/unit) are the same and the new contribution margin of Model LX is $545/unit.
The algebraic equation is stated as follows;
Maximize 260x1 + 545x2 – 385,000 (profit objective)

The EXCEL Solver results are shown in Exhibit 3A-3C. The optimal monthly production plan is
400 units of Model S and 1,400 units of Model LX. With the new selling price of Model LX
and the new optimal product plan, the total profit is increased to $482,000/month.

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Table 4 shows the results comparison in question C and D. The change in contribution margin
of Model S to the total profit is more sensitive than the Model LX by comparing the % Profit
change to the % Contribution margin change. The graphical presentation on the total profit
and the contribution margin from the current plan (Base case: total profit $268,250) to each
sensitivity case are shown below. We would recommend focusing on the contribution margin
improvement on Model S before Model LX as Model S has more impact to the total profit than
Model LX.

Table 4: Comparison between changes in product Contribution Margin


Contribution Margin Optimal Production Total % Profit
Case ($/unit) (Units) Profit % Contribution Change
Margin Change from
Model S Model LX Model S Model LX $ from Base Base
268,2
Base Case 260 245 1900 650 50 0% 0%
Increase Model S 78,2
material cost by $100 160 245 1900 650 50 Model S -38% -71%
Increase Model LX 724,2
selling price by $300 260 545 1900 650 50 Model LX +122% 170%

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