Name: Falguni Pandit

MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032

MB0032
Registration No.: 520966021

Page No: 1

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032 Set – 1
1. Describe the broad classification of Operations Research models in details. Name the different steps needed in OR approach of problem solving? Answer: A model is known as the representation of the reality. It is known as an idealized representation or abstraction of a real life system. The main objective of this model is to identify significant factors and their interrelationship. A model is helpful is decision making as it provides a simplified description of complexities and uncertainties of a problem in logical structure. A broad classification of OR models: a) Physical modes include all form of diagrams, graphs and charts. They are designed to deal with specific problems. They bring out significant factors and inter-relationship in pictorial firm so as to facilitate analysis. There are two types: 1) Ieonic models and 2) Analog models Iconic model is known as an image of an object or system that is represented on a small scale. We can say that these models can simulate the actual performance of a product. On the other hand analog models are small physical systems that have similar characteristics and work like an object. For example- Toy. b) Mathematical Model or Symbolic models represent the decision variable of the system. The model employs a set of mathematical symbols also. The variables are related by mathematical system also. For example Allocation, sequencing, replacement models etc. c) It is by nature of Environment We have 1) Deterministic model in which every thing is defined and the results are certain. Eg: EOQ model 2) Probabilistic models in which the input and output variables follow a probability distribution Eg: Games Theory. d) By the extent of Generality: The tow models belonging to this class are 1) General model canbe applied in general and does not pertain to one problem only. Eg: Linear Programming 2) Specific model is applicable under specific condition only. For example Sales can response curve or equation which can be known as a function of advertising that is applicable in the marketing function alone. The scientific method translates a real given problem into a mathematical representation which is solved and retransformed into the original context. The OR approach to problem solving consists of the following steps: 1) Definition of the problem The first and the most important requirement is that the root problem should be identified and understood. The problem should be identified properly, this indicates three major aspects: 1) A description of the goal or the objective of the study, 2) an identification of the decision alternative to the system, and Page No: 2
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
3) a recognition of the limitations, restrictions and requirements of the system. 2) Construction of the model Depending on the definition of the problem, the operations research team should decide on the most suitable model for representing the system. Such a model should specify quantitative expressions for the objective and the constraints of the problem in terms of its decision variables. 3) Solution of the model Once an appropriate model has been formulated the next stage in the analysis calls for its solution and the interpretation of the solution in the context of the given problem – A solution to a model implies determination of a specific set of decision variables that would yield on optimum solution. An optimum solution is one which maximizes or minimizes the performance of any measure in a model subject to the condition and constraints imposed on the model. 4) Validation the model A model is a good representative of a system, and then the optimal solution must improve the system’s performance. A common method for testing the validity of a model is to compare its performance with some post data available for the actual system. 5) About Implementation of the final result The optimal solution obtained from a model should be applied practice to improve the performance of the system and the validity of the solution should be verified under changing conditions. 2. Describe the graphical method to solve the Linear Programming Problem. Use the following example – Maximize Z = 30x1 + 40x2 Subject to the constraints 1.5x1 + 1.9x2 ≤ 600 0.3 x1 + 0.2x2 ≤ 100 0.0x1 + 0.2x2 ≤ 30 and x1 ≥ 0, x2 ≥ 0 Answer: A LPP with 2 decision variables x1 and x2 can be solved easily by graphical method. We consider the x1 x2 – plane where we plot the solution space, which is the space enclosed by the constraints. Usually the solution space is a convex set which is bounded by a polygon; since a linear function attains extreme (maximum or minimum) values only on boundary of the region, it is sufficient to consider the vertices of the polygon and find the value of the objective function in these vertices.

Page No: 3

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
By comparing the vertices of the objective function at these vertices, we obtain the optimal solution of the problem. The method of solving a LPP on the basis of the above analysis is known as the graphical method. The working rule for the method is as follows: Working Rule: Step I: Write down the equations by replacing the inequality symbols by the equality symbol in the given constraints. Step II: Plot the straight lines represented by the equations obtained in step I. Step III: Identify the convex polygon region relevant to the problem. We must decide on which side of the line, the halfplane is located. Step IV: Determine the vertices of the polygon and find the values of the given objective function Z at each of these vertices. Identify the greatest and least of these values. These are respectively the maximum and minimum value of Z. Step V: Identify the values of (x1, x2) which correspond to the desired extreme value of Z. This is an optimal solution of the problem. Solution by Graphical Method Let the horizontal axis represent x1and vertical axis represent x2. plot the constraint lines, feasibility region has been shown in fig.

Any point on the thick line or inside the shaded portion will satisfy all the restrictions of the problem then ABCDE is the feasibility region carried out by the constraints operating on the objective function. This depicts the limits within which the values of the decision variables are permissible. The intersection points C and D can be solved by the linear equations 0.1x2 < 30, 0.1x1 + 1.5x2 = 600, and 0.2x1 + 0.2x2 < 100 i.e. C(150,300) and D(300,180). We work out the revenues at different corners points as tabulated below

Page No: 4

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032

From the above table we find that revenue is maximum at Rs.31500 when 150 unit of X1 and 300 units of X2 are produced. 3. Describe the Penalty Cost method (Big M Method) for solving L.P.P. Answer: Penalty Cost Method Or Big-M Method Consider a L.P.P. when atleast one of the constraints is of the type > or = . While expressing in the standard form, add a non negative variable to each of such constraints. These variables are called artificial variables. Their addition causes violation of the corresponding constraints, since they are added to only one side of an equation, the new system is equivalent to the old system of constraints if and only if the artificial variables are zero. To guarantee such assignments in the optimal solution, artificial variables are incorporated into the objective function with large positive coefficients in a minimization program or very large negative coefficients in a maximization program. These coefficients are denoted by ± M. Whenever artificial variables are part of the initial solution X0, the last row of simplex table will contain the penalty cost M. The following modifications are made in the simplex method to minimize the error of incorporating the penalty cost in the objective function. This method is called Big M method or Penalty cost method. 1) The last row of the simplex table is decomposed into two rows, the first of which involves those terms not containing M, while the second involves those containing M. 2) The Step 1 of the simplex method is applied to the last row created in the above modification and followed by steps 2, 3 and 4 until this row contains no negative elements. Then step 1 of simplex algorithm is applied to those elements next to the last row that are positioned over zero in the last row.

Page No: 5

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
3) Whenever an artificial variable ceases to be basic, it is removed from the first column of the table as a result of step 4, it is also deleted from the top row of the table as is the entire column under it. 4) The last row is removed from the table whenever it contains all zeroes. 5) If non zero artificial variables are present in the final basic set, then the program has no solution. In contrast, zero valued artificial variables in the final solution may exist when one or more of the original constraint equations are redundant. 4. Why Duality concept is important in OR? Describe the economic importance of the Duality concept. Answer: The Importance of Duality Concept Is Due To Two Main Reasons i. If the primal contains a large number of constraints and a smaller number of variables, thelabour of computation can be considerably reduced by converting it into the dual problem and then solving it. ii. The interpretation of the dual variable from the loss or economic point of view proves extremely useful in making future decisions in the activities being programmed. Economic importance of duality concept The linear programming problem can be thought of as a resource allocation model in which the objective is to maximize revenue or profit subject to limited resources. Looking at the problem from this point of view, the associated dual problem offers interesting economic interpretations of the L.P resource allocation model. We consider here a representation of the general primal and dual problems in which the primal takes the role of a resource allocation model. Primal Maximize

From the above resource allocation model, the primal problem has n economic activities and m resources. The coefficient cj in the primal represents the profit per unit of activity j. Resource i, whose maximum availability is bi, is consumed at the rate aij units per unit of activity j.Interpretation of Duel Variables – For any pair of feasible primal and dual solutions, (Objective value in the maximization problem) ≤ (Objective value in the minimization problem) At the optimum, the relationship holds as a strict equation. Note: Here the sense of optimization is very important. Hence Page No: 6

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
clearly for any two primal and dual feasible solutions, the values of the objective functions, when finite, must satisfy the following inequality.

The strict equality, z = w, holds when both the primal and dual solutions are optimal. Consider the optimal condition z = w first given that the primal problem represents a resource allocation model, we can think of z as representing profit in Rupees. Because bi represents the number of units available of resource i, the equation z = w can be expressed as profit (Rs) = Σ (units of resource i) x (profit per unit of resource i) This means that the dual variables yi, represent the worth per unit of resource i [variables yi are also called as dual prices, shadow prices and simplex multipliers]. With the same logic, the inequality z < w associated with any two feasible primal and dual solutions is interpreted as (profit) < (worth of resources) This relationship implies that as long as the total return from all the activities is less than the worth of the resources, the corresponding primal and dual solutions are not optimal. Optimality is reached only when the resources have been exploited completely, which can happen only when the input equals the output (profit). Economically the system is said to remain unstable (non optimal) when the input (worth of the resources) exceeds the output (return). Stability occurs only when the two quantities are equal. 5. Describe the Matrix Minimum method of finding the initial basic feasible solution in the transportation problem. Answer: The Initial basic Feasible solution using Matrix Minimum Method Let us consider a T.P involving m-origins and n-destinations. Since the sum of origin capacities equals the sum of destination requirements, a feasible solution always exists. Any feasible solution satisfying m + n – 1 of the m + n constraints is a redundant one and hence can be deleted. This also means that a feasible solution to a T.P can have at the most only m + n – 1 strictly positive component, otherwise the solution will degenerate. It is always possible to assign an initial feasible solution to a T.P. in such a manner that the rim requirements are satisfied. This can be achieved either by inspection or by following some simple rules. We begin by imagining that the transportation table is blank i.e. initially all xij = 0. The simplest procedures for initial allocation discussed in the following section. Matrix Minimum Method

Page No: 7

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Step 1:Determine the smallest cost in the cost matrix of the transportation table. Let it be cij , Allocate xij = min ( ai, bj) in the cell ( i, j) Step 2: If xij = ai cross off the ith row of the transportation table and decrease bj by ai go to step 3. if xij = bj cross off the ith column of the transportation table and decrease ai by bj go to step 3. if xij = ai= bj cross off either the ith row or the ith column but not both. Step 3: Repeat steps 1 and 2 for the resulting reduced transportation table until all the rim requirements are satisfied whenever the minimum cost is not unique make an arbitrary choice among the minima.

Page No: 8

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
6. What do you understand by the Integer Programming Problem? Describe the Gomory’s All-I.P.P. method for solving the I.P.P. problem. Answer: Integer Programming Problem The Integer Programming Problem I P P is a special case of L P P where all or some variables are constrained to assume nonnegative integer values. This type of problem has lot of applications in business and industry where quite often discrete nature of the variables is involved in many decision making situations. Eg. In manufacturing the production is frequently scheduled in terms of batches, lots or runs; In distribution, a shipment must involve a discrete number of trucks or aircrafts or freight cars . An integer programming problem can be described as follows: Determine the value of unknowns x1, x2, … , xn so as to optimize z = c1x1 +c2x2 + . . .+ cnxn subject to the constraints ai1 x1 + ai2 x2 + . . . + ain xn =bi , i = 1,2,…,m and xj > 0 j = 1, 2, … ,n where xj being an integral value for j = 1, 2, … , k ≤ n. If all the variables are constrained to take only integral value i.e. k = n, it is called an all (or pure) integer programming problem. In case only some of the variables are restricted to take integral value and rest (n – k) variables are free to take any non negative values, then the problem is known as mixed integer programming problem. Gomory’s All – IPP Method An optimum solution to an I. P. P. is first obtained by using simplex method ignoring the restriction of integral values. In the optimum solution if all the variables have integer values, the current solution will be the desired optimum integer solution. Otherwise the given IPP is modified by inserting a new constraint called Gomory’s or secondary constraint which represents necessary condition for integrability and eliminates some non integer solution without losing any integral solution. After adding the secondary constraint, the problem is then solved by dual simplex method to get an optimum integral solution. If all the values of the variables in this solution are integers, an optimum inter-solution is obtained, otherwise another new constrained is added to the modified L P P and the procedure is repeated. An optimum integer solution will be reached eventually after introducing enough new constraints to eliminate all the superior non integer solutions. The construction of additional constraints, called secondary or Gomory’s constraints, is so very important that it needs special attention. The iterative procedure for the solution of an all integer programming problem is as follows: Step 1: Convert the minimization I.P.P. into that of maximization, if it is in the minimization form. The integrality condition should be ignored. Page No: 9

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Step 2: Introduce the slack or surplus variables, wherever necessary to convert the inequations into equations and obtain the optimum solution of the given L.P.P. by using simplex algorithm. Step 3: Test the integrality of the optimum solution a) If the optimum solution contains all integer values, an optimum basic feasible integer solution has been obtained. b) If the optimum solution does not include all integer values then proceed onto next step. Step 4: Examine the constraint equations corresponding to the current optimum solution. Let these equations be represented by

Where n’ denotes the number of variables and m’ the number of equations. Choose the largest fraction of bis ie to find {bi}i Let it be [bk 1] or write is as f ko Step 5: Express each of the negative fractions if any, in the k th row of the optimum simplex table as the sum of a negative integer and a nonnegative fraction. Step 6: Find the Gomorian constraint

and add the equation

to the current set of equation constraints. Step 7: Starting with this new set of equation constraints, find the new optimum solution by dual simplex algorithm. (So that Gsla (1) is the initial leaving basic variable). Step 8: If this new optimum solution for the modified L.P.P. is an integer solution. It is also feasible and optimum for the given I.P.P. otherwise Page No: 10
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
return to step 4 and repeat the process until an optimum feasible integer solution is obtained.

Page No: 11

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
1. Describe in details the OR approach of problem solving. What are the limitations of the Operations Research? Answer: The OR approach to problem solving consists of the following steps: 1. Definition of the problem. 2. Construction of the model. 3. Solution of the model. 4. Validation of the model. 5. Implementation of the final result. 1. Definition of the problem The first and the most important requirement is that the root problem should be identified and understood. The problem should be identified properly, this indicates three major aspects: (1) a description of the goal or the objective of the study, (2) an identification of the decision alternative to the system, and (3) a recognition of the limitations, restrictions and requirements of the system. 2. Construction of the model Depending on the definition of the problem, the operations research team should decide on the most suitable model for representing the system. Such a model should specify quantitative expressions for the objective and the constraints of the problem in terms of its decision variables. A model gives a perspective picture of the whole problem and helps tackling it in a well organized manner. If the resulting model fits into one of the common mathematical models, a convenient solution may be obtained by using mathematical techniques. If the mathematical relationships of the model are too complex to allow analytic solutions, a simulation model may be more appropriate. There are various types of models which can be constructed under different conditions. 3. Solution of the model Once an appropriate model has been formulated, the next stage in the analysis calls for its solution and the interpretation of the solution in the context of the given problem. A solution to a model implies determination of a specific set of decision variables that would yield an Optimum solution. An Optimum solution is one which maximize or minimize the performance of any Page No: 12

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
measure in a model subject to the conditions and constraints imposed on the model. 4. Validation the model A model is a good representative of a system, then the Optimal solution must improve the system’s performance. A common method for testing the validity of a model is to compare its performance with some past data available for the actual system. The model will be valid if under similar conditions of inputs, it can reproduce the past performance of the system. The problem here is that there is no assurance that future performance will continue to duplicate past behavior. Also, since the model is based on careful examination of past data, the comparison should always reveal favorable results. In some instances this problem may be overcome by using data from trial runs of the system. It must be noted that such a validation method is not appropriate for nonexistent systems, since data will not be available for comparison. 5. Implementation of the final result The optimal solution obtained from a model should be applied practice to improve the performance of the system and the validity of the solution should be verified under changing conditions. It involves the translation of these results into detailed operating instructions issued in an understandable form to the individuals who will administer and operate the recommended system. The interaction between the operations research team and the operating personnel will reach its peak in this phase. Limitations of OR The limitations are more related to the problems of model building, time and money factors. i) Magnitude of computation: Modern problem involve large number of variables and hence to find interrelationship, among makes it difficult. ii) Non – quantitative factors and Human emotional factor cannot be taken into account. iii) There is a wide gap between the managers and the operation researches iv) Time and Money factors when the basic data is subjected to frequent changes then incorporation of them into OR models is a costly affair. v) Implementation of decisions involves human relations and behaviour. 2. What are the characteristics of the standard form of L.P.P.? What is the standard form Page No: 13
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
of L.P.P.? State the fundamental theorem of L.P.P.. Answer: The Standard Form Of LPP The characteristics of the standard form are: 1. All constraints are equations except for the non negativity condition which remain inequalities (>, 0) only. 2. The right hand side element of each constraint equation is nonnegative. 3. All variables are non-negative. 4. The objective function is of the maximization or minimization type. The inequality constraints can be changed to equations by adding or subtracting the left hand side of each such constraints by a nonnegative variable. The nonnegative variable that has to be added to a constraint inequality of the form < to change it to an equation is called a slack variable. The non-negative variable that has to be substracted from a constraint inequality of the form ³ to change it to an equation is called a surplus variable. The right hand side of a constraint equation can be made positive by multiplying both sides of the resulting equation by (-1) wherever necessary. The remaining characteristics are achieved by using the elementary transformations introduced with the canonical form. The Standard Form Of The LPP Any standard form of the L.P.P. is given by

Fundamental Theorem Of L.P.P. Given a set of m simultaneous linear equations in n unknowns/variables, n > m, AX = b, with r(A) = m. If there is a feasible solution X > 0, then there exists a basic feasible solution. 3. Describe the Two-Phase method of solving a linear programming problem with an example. Answer: Two Phase Method The drawback of the penalty cost method is the possible computational error that could result Page No: 14
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
from assigning a very large value to the constant M. To overcome this difficulty, a new method is considered, where the use of M is eliminated by solving the problem in two phases. They are Phase I: Formulate the new problem by eliminating the original objective function by the sum of the artificial variables for a minimization problem and the negative of the sum of the artificial variables for a maximization problem. The resulting objective function is optimized by the simplex method with the constraints of the original problem. If the problem has a feasible solution, the optimal value of the new objective function is zero (which indicates that all artificial variables are zero). Then we proceed to phase II. Otherwise, if the optimal value of the new objective function is non zero, the problem has no solution and the method terminates. Phase II : Use the optimum solution of the phase I as the starting solution of the original problem. Then the objective function is taken without the artificial variables and is solved by simplex method. Examples: 7) Use the two phase method to Maximise z = 3x1 – x2 Subject to 2x1 + x2 > 2 x1 + 3x2 < 2 x2 < 4, x1, x2 > 0 Rewriting in the standard form, Maximize z = 3x1 – x2 + 0S1 – MA1 + 0.S2 + 0.S3 Subject to 2x1 + x2 – S1 + A1 = 2 x1 + 3x2 + S2 = 2 x2 + S3 = 4, x1, x2, S1, S2, S3, A1 > 0. Phase I : Consider the new objective, Maximize Z* = – A1 Subject to 2x1 + x2 – S1 + A1 = 2 x1 + 3x2 + S2 = 2 x2 + S3 = 4, x1, x2, S1, S2, S3, A1 > 0.

Page No: 15

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Solving by Simplex method, the initial simplex table is given by

x1 enters the basic set replacing A1. The first iteration gives the following table:

Phase I is complete, since there are no negative elements in the last row. The Optimal solution of the new objective is Z* = 0. Phase II: Consider the original objective function, Maximize z = 3x1 – x2 + 0S1 + 0S2 + 0S3 Subject to

x2 + S3 = 4 x1, x2, S1, S2, S3 > 0

Page No: 16

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
with the initial solution x1 = 1, S2 = 1, S3 = 4, the corresponding simplex table is

Proceeding to the next iteration, we get the following table:

Since all elements of the last row are non negative, the current solution is optimal. The maximum value of the objective function Z = 6 which is attained for x1 = 2, x2 = 0. 4. What do you understand by the transportation problem? What is the basic assumption behind the transportation problem? Describe the MODI method of solving transportation problem. Answer: This model studies the minimization of the cost of transporting a commodity from a number of sources to several destinations. The supply at each source and the demand at each destination are known. The transportation problem involves m sources, each of which has available ai (i = 1, 2, …..,m) units of homogeneous product and n destinations, each of which requires bj (j = 1, 2…., n) units of products. Here ai and bj are positive integers. The cost cij of transporting one unit of the product from the i th source to the j th destination is given for each i Page No: 17
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
and j. The objective is to develop an integral transportation schedule that meets all demands from the inventory at a minimum total transportation cost. It is assumed that the total supply and the total demand are equal.

The condition (1) is guaranteed by creating either a fictitious destination with a demand equal to the surplus if total demand is less than the total supply or a (dummy) source with a supply equal to the shortage if total demand exceeds total supply. The cost of transportation from the fictitious destination to all sources and from all destinations to the fictitious sources are assumed to be zero so that total cost of transportation will remain the same. The Transportation Algorithm (MODI Method) The first approximation to (2) is always integral and therefore always a feasible solution. Rather than determining a first approximation by a direct application of the simplex method it is more efficient to work with the table given below called the transportation table. The transportation algorithm is the simplex method specialized to the format of table it involves: i) finding an integral basic feasible solution ii) testing the solution for optimality iii) improving the solution, when it is not optimal iv) repeating steps (ii) and (iii) until the optimal solution is obtained. The solution to T.P is obtained in two stages. In the first stage we find Basic feasible solution by any one of the following methods a) Northwest corner rale b) Matrix Minima Method or least cost method c) Vogel’s approximation method. In the second stage we test the B.Fs for its optimality either by MODI method or by stepping stone method. Modified Distribution Method / Modi Method / U – V Method. Step 1: Under this method we construct penalties for rows and columns by subtracting the least value of row / column from the next least value. Step 2: We select the highest penalty constructed for both row and column. Enter that row / column and select the minimum cost and allocate min (ai, bj) Step 3: Delete the row or column or both if the rim availability / requirements is met. Step 4: We repeat steps 1 to 2 to till all allocations are over. Page No: 18
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Step 5: For allocation all form equation ui + vj = cj set one of the dual variable ui / vj to zero and solve for others. Step 6: Use these value to find Δij = cij – ui – vj of all Δij >, then it is the optimal solution. Step 7: If any Dij £ 0, select the most negative cell and form loop. Starting point of the loop is +ve and alternatively the other corners of the loop are –ve and +ve. Examine the quantities allocated at –ve places. Select the minimum. Add it at +ve places and subtract from –ve place. Step 8: Form new table and repeat steps 5 to 7 till Δij > 0 5. Describe the North-West Corner rule for finding the initial basic feasible solution in the transportation problem. Answer: North West Corner Rule Step1: The first assignment is made in the cell occupying the upper left hand (north west) corner of the transportation table. The maximum feasible amount is allocated there, that is x11 = min (a1,b1) So that either the capacity of origin O1 is used up or the requirement at destination D1 is satisfied or both. This value of x11 is entered in the upper left hand corner (small square) of cell (1, 1) in the transportation table Step 2: If b1 > a1 the capacity of origin O, is exhausted but the requirement at destination D1 is still not satisfied , so that at least one more other variable in the first column will have to take on a positive value. Move down vertically to the second row and make the second allocation of magnitude x21 = min (a2, b1 – x21) in the cell (2,1). This either exhausts the capacity of origin O2 or satisfies the remaining demand at destination D1. If a1 > b1 the requirement at destination D1 is satisfied but the capacity of origin O1 is not completely exhausted. Move to the right horizontally to the second column and make the second allocation of magnitude x12 = min (a1 – x11, b2) in the cell (1, 2) . This either exhausts the remaining capacity of origin O1 or satisfies the demand at destination D2 . If b1 = a1, the origin capacity of O1 is completely exhausted as well as the requirement at destination is completely satisfied. There is a tie for second allocation, An arbitrary tie breaking Page No: 19
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
choice is made. Make the second allocation of magnitude x12 = min (a1 – a1, b2) = 0 in the cell (1, 2) or x21 = min (a2, b1 – b2) = 0 in the cell (2, 1). Step 3: Start from the new north west corner of the transportation table satisfying destination requirements and exhausting the origin capacities one at a time, move down towards the lower right corner of the transportation table until all the rim requirements are satisfied. 6. Describe the Branch and Bound Technique to solve an I.P.P. problem. Answer: The Branch And Bound Technique Sometimes a few or all the variables of an IPP are constrained by their upper or lower bounds or by both. The most general technique for the solution of such constrained optimization problems is the branch and bound technique. The technique is applicable to both all IPP as well as mixed I.P.P. the technique for a maximization problem is discussed below: Let the I.P.P. be

Subject to the constraints

xj is integer valued , j = 1, 2, …….., r (< n) –––– (3) xj > 0 …………………. j = r + 1, …….., n ––––––––––(4) Further let us suppose that for each integer valued xj, we can assign lower and upper bounds for the optimum values of the variable by Lj ≤ xj ≤ Uj j = 1, 2, …. r ––––––––––––– (5) The following idea is behind “the branch and bound technique” Consider any variable xj, and let I be some integer value satisfying Lj £ I £ Uj – 1. Then clearly an optimum solution to (1) through (5) shall also satisfy either the linear constraint. x j > I + 1 ––––––––––––– ( 6) Or the linear constraint xj ≤ I ………………...(7) To explain how this partitioning helps, let us assume that there were no integer restrictions (3), and suppose that this then yields an optimal solution to L.P.P. – (1), (2), (4) and (5). Indicating x1 = 1.66 (for example). Then we formulate and solve two L.P.P’s each containing (1), (2) and (4). But (5) for j = 1 is modified to be 2 ≤ x1 ≤ U1 in one problem and L1 ≤ x1 ≤ 1 in the other. Page No: 20
Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Further each of these problems process an optimal solution satisfying integer constraints (3) Then the solution having the larger value for z is clearly optimum for the given I.P.P. However, it usually happens that one (or both) of these problems has no optimal solution satisfying (3), and thus some more computations are necessary. We now discuss step wise the algorithm that specifies how to apply the partitioning (6) and (7) in a systematic manner to finally arrive at an optimum solution. We start with an initial lower bound for z, say z (0) at the first iteration which is less than or equal to the optimal value z*, this lower bound may be taken as the starting Lj for some xj. In addition to the lower bound z (0) , we also have a list of L.P.P’s (to be called master list) differing only in the bounds (5). To start with (the 0 th iteration) the master list contains a single L.P.P. consisting of (1), (2), (4) and (5). We now discuss below, the step by step procedure that specifies how the partitioning (6) and (7) can be applied systematically to eventually get an optimum integer valued solution.

Set – 2
Q1: Compare and contrast NPV with IRR. ANS 1. Net present value method The cash inflow in different years are discounted (reduced) to their present value by applying the appropriate discount factor or rate and the gross or total present value of cash flows of different years are ascertained. The total present value of cash inflows are compared with present value of cash outflows (cost of project) and the net present value or the excess present value of the project and the difference between total present value of cash inflow and present value of cash outflow is ascertained and on this basis, the various investments proposals are ranked.

Page No: 21

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

Cash inflow = earnings / profits of an investment after taxes but before depreciation The present value of cash outflows = initial cost of investment and the comment of project at various points of time ^ Decision rule After ranking various investments proposals on basis on net present value, projects with negative net present value (net present value of cash inflows less than their original costs) are rejected and projects with positive NPV are considered acceptable. In case of mutually exclusive alternative projects, projects with higher net present value are selected. Net present value method is suitable for evaluating projects where cash flows are uneven. Merits 1. The most significant advantage is that it explicitly recognizes the time value of money, e.g., total cash flows pertaining to two machines are equal but the net present value are different because of differences of pattern of cash streams. The need for recognizing the total value of money is thus satisfied. 2. It also fulfills the second attribute of a sound method of appraisal. In that it considers the total benefits arising out of proposal over its life time. 3. It is particularly useful for selection of mutually exclusive projects. 4. This method of asset selection is instrumental for achieving the objective of financial management, which is the maximization of the shareholder's wealth. In brief the present value method is a theoretically correct technique in the selection of investment proposals. Demerits 1. It is difficult to calculate as well as to understand and use, in comparison with payback method or average return method. 2. The second and more serious problem associated with present value method is that it involves calculations of the required rate of return to discount the cash flows. The discount rate is the most important element used in the calculation of the present value because different discount rates will give different present values. The relative desirability of a proposal will change with the change of discount rate. The importance of the discount rate is thus obvious. But the calculation of required rate of return pursuits serious problem. The cost of capital is generally the basis of the firm's discount rate. The calculation of cost of capital is very complicated. In fact there is a difference of opinion even regarding the exact method of calculating it. 3. Another shortcoming is that it is an absolute measure. This method will accept the project which has higher present value. But it is likely that this project may also involve a larger initial outlay. Thus, in case of projects involving different outlays, the present value may not give dependable results. 4. The present value method may also give satisfactory results in case of two projects having different effective lives. The project with a shorter economic life

OPERATIONS RESEARCH - MB0032

Page No: 22

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

is preferable, other things being equal. It may be that, a project which has a higher present value may also have a larger economic life, so that the funds will remain invested for longer period while the alternative proposal may have shorter life but smaller present value. In such situations the present value method may not reflect the true worth of alternative proposals. This method is suitable for evaluating projects whose capital outlays or costs differ significantly. Internal rate of return method The technique is also known as yield on investment, marginal efficiency value of capital, marginal productivity of capital, rate of return, time adjusted rate of return and so on. Like net present value, internal rate of return method also considers the time value of money for discounting the cash streams. The basis of the discount factor however, is difficult in both cases. In the net present value method, the discount rate is the required rate of return and being a predetermined rate, usually cost of capital and its determinants are external to the proposal under consideration. The internal rate of return on the other hand is based on facts which are internal to the proposal. In other words, while arriving at the required rate of return for finding out the present value of cash flows, inflows and outflows are not considered. But the IRR depends entirely on the initial outlay and cash proceeds of project which is being evaluated for acceptance or rejection. It is therefore appropriately referred to as internal rate of return. The IRR is usually, the rate of return that a project earns. It is defined as the discount rate which equates the aggregate present value of net cash inflows (CFAT) with the aggregate present value of cash outflows of a project. In other words it is that rate which gives the net present value zero. IRR is the rate at which the total of discounted cash inflows equals the total of discounted cash outflows (the initial cost of investment). It is used where the cost of investment and its annual cash inflows are known but the rate of return or discounted rate is not known and is required to be calculated. Accept / Reject decision The use of IRR as a criterion to accept capital investment decision involves a comparison of actual IRR with required rate of return, also known as cut off rate or hurdle rate. The project should qualify to be accepted if the internal rate of return exceeds the cut off rate. If the internal rate of return and the required rate of return be equal, the firm is indifferent as to accept or reject the project. In case of mutually exclusive or alternative projects, the project which has the highest IRR will be selected provided its IRR is more than the cut off rate. In case there are budget constraints, the projects are ranked in descending order of their IRR and are selected subject to provisions. Evaluation of IRR 1. Is a theoretically correct technique to evaluate capital expenditure decision. It possesses the advantages which are offered by the NPV criterion such as, it considers the time value of money and takes into account the total cash inflows and outflows. 2. In addition, the IRR is easier to understand. Business executives and nontechnical people understand the concept of IRR much more readily than they understand the concept of NPV. For instance, Business X will

OPERATIONS RESEARCH - MB0032

Page No: 23

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

understand the investment proposal in a better way if it is said that the total IRR of Machine B is 21% and cost of capital is 10% instead of saying that NPV of Machine B is Rs. 15,396. 3. It itself provides a rate of return which is indicative of profitability of proposal. The cost of capital enters the calculation later on. 4. It is consistent with overall objective of maximizing shareholders wealth. According to IRR, the acceptance / rejection of a project is based on a comparison of IRR with required rate of return. The required rate of return is the minimum rate which investors expect on their investment. In other words, if the actual IRR of an investment proposal is equal to the rate expected by the investors, the share prices will remain unchanged. Since, with IRR, only such projects are accepted which have IRR of the required rate, therefore, the share prices will tend to rise. This will naturally lead of maximization of shareholders wealth. ^ The IRR suffers from serious limitations: 1. It involves tedious calculations. It involves complicated computation problems. 2. It produces multiple rates which can be confusing. This situation arises in the case of non-conventional projects. 3. In evaluating mutually exclusive proposals, the project with highest IRR would be picked up in exclusion of all others. However in practice it may not turn out to be the most profitable and consistent with the objective of the firm i.e., maximization of shareholders wealth. 4. Under IRR, it is assumed that all intermediate cash flows are reinvested at the IRR. It is rather ridiculous to think that the same firm has the ability to reinvest the cash flows at different rates. The reinvestment rate assumption under the IRR is therefore very unrealistic. Moreover it is not safe to assume always that intermediate cash flows from the project may be reinvested at all. A portion of cash inflows may be paid out as dividends, a portion may be tied up with current assets such as stock, cash, etc. Clearly, the firm will get a wrong picture of the project if it assumes that it invests the entire intermediate cash proceeds. Further it is not safe to assume that they will be reinvested at the same rate of return as the company is currently earning on its capital (IRR) or at the current cost of capital (k). NPV versus IRR NPV indicates the excess of the total present value of future returns over the present value of investments. IRR (or DFC rate) indicates on the other hand the rate at which the cash flows (at present values) are generated in the business by a particular project. Both NPV and IRR iron out the difference due to interest factor or say higher returns in earlier years and higher returns in later years (though the total returns in absolute terms may be around the same for several projects). Between the two, IRR or DFC rate is the more sophisticated method ¬a popular as well, since: (a) IRR method -mostly subjective decision regarding discounting rate. ^

OPERATIONS RESEARCH - MB0032

Page No: 24

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
(b) Whilst under NPV the main basis of comparison is between different NPV's of different projects, under IRR or DFC rate approach a number of basis is available. For example ¬ DFC rate Vs Discount rate of return (on normal operations) ^ DFC rate Vs Cut off rate of the company DFC rate Vs Borrowing rate (on cost of capital) DFC rates between different projects (c) The results under DFC rate approach are simpler for the management to understand and appreciate. We should however be very careful in applying the decision rules properly when NPV and IRR calculation shows divergent results. The rules are ¬ (i) the projects be the basis of decision when mutually exclusive in character; (ii) there is capital rationing situation (d) IRR should be a better guide when there are plenty of project situations (as it is there in a long enterprise) and no major constraints (for example, in respect of macro projects).

Page No: 25

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

Q2: Zodiac Ltd is considering purchase of investment worth Rs. 40 lakhs. The estimated life and the new cash flow fir 3 years are as under. Machines A Estimated life 3 Years Cash inflows(in lakhs) 1 Year 27 2 Year 18 3 Year 55 Ans 2 A) Payback period B 3 Years 06 21 33 C 3years 12 80 30

OPERATIONS RESEARCH - MB0032

Machine A. Rs.27 lakhs will be recovered in 1st year & the balance 13 lakhs (40 – 27) will be recovered in 2nd year of 18 lakhs Payback period = 1year +(13/18*12month) or =1year +13/18 1 year 8.6 month = 1year + 0.72 1.72year machine B. Rs.06 lakhs will be recovered in 1st year & the balance 34 lakhs (40 – 6) will be recovered in 2nd year of 21 lakhs payback period = 1year +(35/21*12month) or =1year + 35/21 = 1year 20 month = 1year +1.66 2.66year machine c. Rs.12 lakhs will be recovered in 1st year & the balance 28 lakhs (40 – 12) will be recovered in 2nd year of 80 lakhs payback period = 1year + (28/80*12month) or =1year + 28/80 = 1year + 4.2 month = 1year + 0.35 = 1.35year

Page No: 26

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032

machine A. Rs. 35.4546 will be recovered in 2nd year & balance 4.5454(4035.4546) will be recovered in 3rd year out of 39.149 =2year + (4.5454/39.149) =2year + 0.1161 =2.11year machine A. Rs. 22.0968 will be recovered in 2nd year & balance 17.9032(4022.0968) will be recovered in 3rd year out of 23.489 =2year + (17.9032/23.489) =2year +0.7621 =2.76year machine A. Rs. 74.4936 will be recovered in 2nd year & balance -34.4936 (40- 74.4936) will be recovered in 3rd year out of 95.8436 =2year + (-34.4936/95.8436) =2year + -0.3598 = 1.64year

Page No: 27

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Q3: The cash flow stream of Nanotech Ltd, is as follows: years Cash flows (in millions) 0 -120 1 -100 2 40 3 60 4 80 5 100 6 130

The cost of capital is 13% find MIRR. Ans 3:

Present value of cost = 120 * 100/1.13 = 194.69 Terminal value of cash flow 432 = 40(1.13) + 60(1.13) +80(1.13)+100(1.13)+130 = 40*1.6305 + 60*1.4429 + 80*1.2769 + 113 + 130 =496.95 MIRR is obtain on solving the following equation. 6 194.69 = 496.95/(1+mirr) 6 (1+mirr) = 496.95/194.69 6 (1+mirr) = 2.5525
Q3: Elaborate different sources of risk in a project ANS. Risk in the project are many. It is possible to identify three separate and distinct type of risk in any project. 1. Stand – alone risk : it is measured by the variability of expected returns of the project 2. portfolio risk : a firm can be viewed as portfolio of projects having a certain degree of risk. When new project is added to the existing portfolio of project, the risk profile of the firm will alter. The degree of the change in the risk depends on the existing portfolio of the projects. If the return from the new project is negatively correlated with the return from portfolio, the risk of the firm will be further diversified away. 3. market or beta risk: it is measured by the effect of the project on the beta of the firm. The market risk for a project is difficult to estimate. Stand alone risk of a project when the project is considered in isolation. Corporate risk is the projects risks of the firm. Market risk is systematic risk. The market risk is the most important risk because of the direct influence it has on stock prices. Source of risk: the source of risk are 1. project – specific risk 2. competitive or competition risk 3. industry - specific risk 4. international risk

Page No: 28

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

5. market risk

OPERATIONS RESEARCH - MB0032

1. project – specific risk: the source of this risk could be traced to something quite specific to the project. Managerial deficiencies or error in estimation of cash flow or discount rate may lead to a situation of actual cash flow relised being less than that projected. 2. competitive risk or competition risk: unanticipated of a firm’s competitors will materially affect the cash flows expected from a project. Because of this the actual cash flow from a project will be less than that of the forecast. 3. industry- specific : industry – specific risks are those that affect all the firms in the industry. It could be again grouped in to technological risk, commodity risk and legal risk. All these risks will affect the earnings and cash flows of the project. The changes in technology affect all the firms not capable of adapting themselves to emerging new technology. The best example is the case of firm manufacturing motors cycles with two stroke engines. When technological innovation replaced the two stroke engines by the four stroke engines those firms which could not adapt to new technology had to shut down their operations. Commodity risk is the arising from the affect of price – changes on goods produced and marketed. Legal risk arise from changes in laws and regulations application to the industry to which the firm belongs. The best example is the imposition of service tax on apartments by the government of India when the total number of apartments built by a firm engaged in that industry exceeds a prescribed limit. Similarly changes in import – export policy of the government of India have led to the closure of some firms or sickness of some firms. 4. international risk : these types of risk are faced by firms whose business consists mainly of exports or those who procure their main raw material from international markets. For example, rupee –dollar crisis affected the software and BPOs because it drastically reduce their profitability. Another best example is that of the textile units in Tirupur in Tamilnadu, exporting their major part of the garments produces. Rupee gaining and dollar weakening reduced their competitiveness in the global markets.

Page No: 29

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Q4: The expected cash flow of Tejaswini Ltd, are an follow. (5 Marks) Year 0 1 2 3 4 5 Cash flow (50000) 9000 8000 7000 12000 21000

The certainty equivalent factor balance as per the following equation α t=1-05.05t. Calculate the NPV of the project if the risk free rate of return is 9%. Ans 4:

Page No: 30

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Q5: From the following information prepare cash budgets for VSI Co. Ltd.: Particulars Opening cash balance Collection from customer Payments : Raw materials purchase Salary and Wages Other expenses Income Tax Machinery Jan 20,000 1,30,000 25,000 1,00,000 15,000 6,000 --Feb 1,60,000 45,000 1,05,000 10,000 ------March 1,65,000 40,000 1,00,000 15,000 ---20,000 April 2,30,000 63200 1,14,200 12,000 -----

The firm wants to maintain a minimum cash balance of Rs.25000 for each month. Creditors are allowed one-month credit. There is no lag in payment of salary, other expenses. Ans 5:

For JAN: Bank over Draft 21,000 for maintain minimum cash balance for month of February 21000+4000=25000. For FEB: No need to take bank over Draft because closing balance 25,000. For MARCH: Bank over Draft 10,000 for maintain minimum cash balance for month of April 15,000+10,000=25000. At last closing balance month of April 65,600 so return to bank 31,000 form month of april , 65,600 – 31,000= 34,400 Page No: 31

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

OPERATIONS RESEARCH - MB0032
Case Study Assume you are an external financial consultant. You have been approached by a client M/s Technotron Ltd to give a presentation on Credit Policy adopted by Information technology companies. You are specifically asked to deal with credit standards, credit period, cash discounts and collection programme. For the sake of simplicity take any two information technology companies and analyze the credit policy followed by them. ANS:Credit policy Variables 1. Credit standards. 2. Credit period. 3. Credit discount and 4. Collection programme. 1. Credit standards : The term credit standards refer to the criteria for extending credit to customers. The bases for setting credit standards are. a. Credit rating b. References c. Average payment period d. Ratio analysis There is always a benefit to the company with the extension of credit to its customers but with the associated risks of delayed payment or non payment, funds blocked in receivables etc. The firm may have light credit standards. It may sell on cash basis and extend credit only to financially strong customers. Such strict credit standards will bring down bad – debt losses and reduce the cost of credit administration. But the firm may not be able to increase its sales. The profit on lost sales may be more the costs saved by the firm. The firm should evaluate the trade – off between cost and benefit ofany credit standards. 2. Credit period: Credit period refer to the length of time allowed to its customers by a firm to make payment for the purchase made by customers of the firm. It is generally expressed in days like 15 days or 20 days. Generally, firms give cash discount if payment are made within the specified period. If a firm follows a credit period of ‘net 20’ it means that it allows to its customers 20 days of credit with no inducement for early payments. Increasing the credit period will bring in additional sales from existing customers and new sales from new customers. Reducing the credit period will lower sales, decrease investments in receivables and reduce the bad debt loss. Increasing the credit period increases the incidence of bad debt loss. The effect of increasing the credit period on profits of the firm are similar to that of relaxing the credit standards. 3. Cash discount: Firms offer cash discount to induce their customer to make prompt payments. Cash discount have implications on sales volume, average collection period, investment in receivables, incidence of bad debt and profits. A cash discount of 2/10 net 20 means that a cash discount of 2% is offered if the

Page No: 32

Name: Falguni Pandit |Registration No.: 520966021

Name: Falguni Pandit
MBA – II SEM

Registration No.: 520966021

payment is made by the tenth day; other wise full payment will have to be made by 20th day. 4. Collection programme : The success of a collection programme depends on the collection policy pursued by the firm. The objective of a collection policy is to achieve. Timely collection of receivable, there by releasing funds locked in receivables and minimize the incidence of bad debts. The collection programmes consists of the following. 1. Monitoring the receivables 2. Reminding customers about due date of payment 3. On line interaction through electronic media to customers about the payments due around the due date. 4. Initiating legal action to recover the amount from overdue customer as the last resort the dues from defaulted customers. Collection policy formulated shall not lead to bad relationship with customers.

OPERATIONS RESEARCH - MB0032

Page No: 33

Name: Falguni Pandit |Registration No.: 520966021

Sign up to vote on this title
UsefulNot useful