HART Venture Capital

Capital Allocation Plan for Security System and Market Analysis

for three years

Table of Content
Abstract

List of Table

II-VIII

State of Problem

Constraints

Analysis of the Problem

Objective Function

Solutions and Results

Graphical Solutions

Extreme Points and Optimal Point

Slack and Surplus

Dual Price

6-7

Range of Optimality

Range of R.H.S Value

9-11

Discussion
Excel Summary
Managerial Report

12
13-16

Conclusion
Work Contribution
Reference Cited

17
18
19

Abstract
Hart Venture Capital (HVC) is a company of providing venture capital for
software development and Internet application. Currently, there are two
companies: Security Systems and Market Analysis need additional capital.
Security package needs additional capital to develop an Internet security
software package; Market Analysis needs additional capital to develop a
software package for conducting customer satisfaction surveys. The company
is trying to find the optimal percentage of each project that HVC should fund
in order to yield the maximum net present value of the total investment.
To solve this problem, linear programming will be used. The problem the
firms faces is a maximization problem. The net present value generated by
the sum of the net present value multiplied by the recommended percentage
of two investments will be the objective function. The answer will be the
optimal point of the feasible region within the constraints of the amount of
capital available.
Capital availability will be the key role in determining how much capital
should be allocated to the two companies over three years. The
recommended percentages for the two companies will remain unchanged
over three years. This paper will solve the problems that the firm faces and
look into the change in objective function if additional capital is provided.

LIST OF TABLES
Page 3

Net Present Value (100

Percent funding)

Security Systems

Market Analysis

1,800,000

1,600,000

Page 4

Years
1
2
3

Investment Opportunities
Security System Stock
Market Analysis
$
600,000
$
500,000
$
600,000
$
350,000
$
250,000
$
400,000

$
$
$

Maximum Investment each year

800,000
700,000
500,000

Page 6
ecurity
System
Stock
Market
Analysis

Optimal
Solution

Algebra

Slope

Maximization

-1600000/180000
0

Intercept

87%

Constrain 1

600000

500000

<= 800000

-500000

Constrain 2

600000

350000

<= 700000

-350000/600000

-0.6

Constrain 3

250000

400000

<= 500000

-400000/250000

-1.6

Constrain 4

>= 0

Undefined

Constrain 5

>= 0

Security System Stock

61%

-0.888888889
600000
-0.833333333

Market Analysis

Algebra

Algebra

800000/600000

1.333333333

800000/500000

1.6

700000/600000

1.166666667

700000/350000

500000/250000

500000/400000

1.3

Slope of a line = y = -mx + b

Page 8
Total Investment in Year 1

S*600,000

M*500,000

800,000

Total Investment in Year 2

S*600,000

M*350,000

700,000

Total Investment in Year 3

S*250,000

M*400,000

500,000

II
Page 16

Security
System Stock

Investment in Year 1

365,217.39

Investment in Year 2

365,217.39

Investment in Year 3

152,173.91

Figures
Page 6

Market
Analysis
$
434,782.61
$
304,347.83
$
347,826.09

total
$

800,000.00

669,565.22

500,000.00

III
Page

Page

IV
Page

Page

V
Page

Page

VI
Page

VII
Page

VIII

Statement of Problem and Process

Identification of the problem
The problem is what percentage of each project that HVC should fund to
generate the maximum net present value of the total investment in Security
System and Market Analysis. Using an 8% rate of return, HVCs financial
analysis team estimate that 100 percent funding of the Security Systems
project has a net present value of $1,800,000 and 100 percent funding of the
Market Analysis project has a net percent value of $1,600,000. HVC has the
option to fund any percentage of the Security Systems and Market Analysis
project. Therefore, let the S be the recommended percentage of Security
Systems that HVC should fund; let the M be the recommended percentage of
Market Analysis that HVC should fund, the net percent value of the Security
Systems would be S*($1,800,000); the net percent value of the Market
Analysis would be M*($1,600,000).

Net Present Value (100

Percent funding)

Security Systems

Market Analysis

1,800,000

1,600,000

Constraints
The constraints are each years investment amount on both projects that
HVC commit at most. In year 1, in exchange for Security Systems stock, the
firm has asked HVC to provide $600,000; in exchange for Market Analysis, the
firm has asked for $500,000; HVC are willing to commit at most $800,000 for
both projects in the first year.
In year 2, Security Systems has asked for $600,000 and Market Analysis
has asked for $350,000; the most investment by HVC in year 2 is $700,000.
In year 3, Security System has asked for $250,000, while the Market
Analysis has asked for $400,000; the maximum investment by HVC is
$500,000.

Years
1
2
3

Investment Opportunities
Security System Stock
Market Analysis
$
600,000
$
500,000
$
600,000
$
350,000
$
250,000
$
400,000

$
$
$

Maximum Investment each year

800,000
700,000
500,000

Analysis of the problem

Objective function
Max 1,800,000 (S) + 1,600,000 (M)
S.T.
600,000 (S) + 500,000 (M)

800,000

600,000 (S) + 350,000 (M) 700,000

250,000 (S) + 400,000 (M)
S 0
M

500,000

Solutions and Results

Graphical Solution

Security
System
Stock

Market
Analysis

Optimal
Solution

Algebra

Slope

Intercept

Security System Stock

Market Analysis

61%

87%

Maximization

-1600000/180000
0

-0.888888889

Algebra

Algebra

Constrain 1

600000

500000

<= 800000

-500000/600000

-0.833333333

800000/600000

1.333333333

800000/500000

1.6

Constrain 2

600000

350000

<= 700000

-350000/600000

-0.6

700000/600000

1.166666667

700000/350000

Constrain 3

250000

400000

<= 500000

-400000/250000

-1.6

500000/250000

500000/400000

1.3

>= 0

Undefined

Constrain 4
Constrain 5

>= 0

Slope of a line = y = -mx + b

There are three extreme points (A, B, C, D) and the optimal point at point C.
The reason is that C is the farthest point from the origin. Point C is on the
intersection of Constrain 1 and 3.
4

Extreme Points and Optimal Point

Therefore:
600,000 (S) + 500,000 (M) = 800,000
+ 5M =8

6S

250,000 (S) + 400,000 (M) = 500,000

2.5S + 4M =5
S= 60.86956%
M= 86.95652%
At the optimal point (point c), HVC should fund 61% of the Security Systems
project and 87% of
the Market Analysis.
The total net present
value will be:
$ 2,486,956.52
Point A

Refer to the graph

S=133%
M =0
At Point A 133% S and 0% M will fund. The total net present value will be:
$ 2,394,000.00

Point B
600,000 (S) + 500,000 (M) = 800,000
6S+5M=8

600,000 (S) + 350,000 (M) = 700,000

6S+3.5M=7
M= 66.66666%
S= 77.77777%
At the Point B, 67% S and 77% M will fund. The total net present value will be:
$ 2,466666.67
Point D
Refer to the graph

S= 0%

M = 125%
At the Point B, 69% S and 82% M will fund. The total net present value will be:
$ 2,000,000.00

Slack and Surplus

Total Investment in Year 1

S*600,000

M*500,000

800,000

Total Investment in Year 2

S*600,000

M*350,000

700,000

Total Investment in Year 3

S*250,000

M*400,000

500,000

To find the slack determine the percentage funded and subtract that from the
total allowable investment that HVC is willing to commit.

The result is that there are slacks in the non-binding constrains. There is still
$ 30,435.00 that could invest in the second year.

Dual Price
The dual price is calculated by adding one additional unit to the right hand
side of a binding constraint. After plugging the results back into the optimal
solution and then subtract the previous optimal solution from the answer.
Constraint 1
600,000 (S) + 500,000 (M) = 800,000
(S) + 500,000 (M) = 800,001
250,000 (S) + 400,000 (M) = 500,000
(S) + 400,000 (M) = 500,000

600,000
250,000
M=

86.95630%
S=
60.86991%
1,800,000*(60.86991%) + 1,600,000*(86.95630%) - 2,486,956.52 = 2.78 = Dual
Price for Constrain 1

Constraint 3

600,000 (S) + 500,000 (M) = 800,000

(S) + 500,000 (M) = 800,000

600,000
6

250,000 (S) + 400,000 (M) = 500,000

(S) + 400,000 (M) = 500,001

250,000
M=

86.95704%
S=
60.86913%
1,800,000*(60.86913%) + 1,600,000*(86.95704%) - 2,486,956.52 = 0.52 = Dual
Price for Constrain 3
If the total investment in year 1 is increase by $1, the net present value will increase by $ 2.78. If
$1 was added to the investment amount of year 3, the net present value will increase by $ 0.52.

Range of Optimality
The range of optimality is how much the optimal solution variable can change until the extreme
point is changed. To calculate this set the slope of the optimal solution between the two binding
solutions.

S
-1.6 - S/M -5/6 = -1.6 -S/1,600,000 -5/6
1.6

S/1,600,000 5/6

1,333,333.33 S 2,560,000
M

-1.6

- S/M -5/6 = -1.6 - 1,800,000/M -5/6

5/6 1,800,000/M 1.6

1,125,000

M 2,160,000

Range of RHS values

To determine the RHS values, move one of the constraints up or down until it
hits an extreme point or an optimal point. Afterwards plug the coordinates of
the point into the constraint that was moved. Then subtract the number from
the original RHS.
Constraint 1

Point D
600,000 (0) + 500,000 (1.25) = 625,000 - 800,000 = -175,000 = maximum
allowable decrease

Point E
600,000 (S) + 350,000 (M) = 700,000
3.5M = 7
250,000 (S) + 400,000 (M) = 500,000
4M =5

6S +
2.5S +
S=

68.852459%
M=
81.9672131%
9
600,000 (68.852459%) + 500,000 (81.9672131%) 800,000 = 22,950.81967 =
maximum allowable increase

Constraint 2

Point C

600,000 (60.86956%) + 350,000 (86.95652%) = 669,565.18 - 700,000 =

-30,434.82 = maximum allowable decrease

= maximum allowable increase

Constraint 3

10

Point B
600,000 (S) + 500,000 (M) = 800,000
+ 5M = 8
600,000 (S) + 350,000 (M) = 700,000
+ 3.5M = 7
M= 66.6666666%
S = 77.7777777%

6S
6S

250,000 (77.7777777%) + 400,000 (66.6666666%) = 461,111.1107 500,000 = - 38888.88935 = maximum allowable decrease
Point F
250,000 (0) + 400,000 (1.6) = 640,000 500,000 = 140,000 = maximum
allowable increase

11

Discussion
Excel Summary

12

Managerial Report
1. The recommended numbers for HVC are 61% of Security Systems stock
and 87% of Market Analysis. The net present value is $ 2,486,956.52.
2. In the first year, HVC should invest $ 365,217.39 in Security Systems Stock and $
434,782.61 in Market Analysis, the total investment amount is $800,000. In the second year,
this company will spend the same amount of money on the Security Systems Stock as the
first year and $ 304,347.83 on Market Analysis, the total investment is $ 669,565.22; in the
last year, HVC can commit $ 152,173.91 for Security System Stock and $ 347,826.09, the
total is $500,000.
Security
System Stock

Investment in Year 1

365,217.39

Investment in Year 2

365,217.39

Investment in Year 3

152,173.91

Market
Analysis
$
434,782.61
$
304,347.83
$
347,826.09

total
$

800,000.00

669,565.22

500,000.00

3. If HVC is willing to commit an additional $100,000 during the first year,

the recommend percentage of the Security System Stock will increase to

69% and the number of Market Analysis will decrease to 82%; the net
present value will change to $2,550,819.67. In this case, the bindings will
change from constraint 1 and 3 to constraint 2 and 3.

13

4. There are four situations to consider:

Case (1) Adding all $100,000 to constraint 1

14
Case (2) Adding all $100,000 to constraint 2

Case (3) Adding all $100,000 to constraint 3

Case (4) According to the optimal solution, adding $22,950.8197 of allowable

increase to constraint 1; the remaining $100,000-22950.8197=$77,049.1803
which within the allowable increase of constraint 3 is added to the R.H.S of
constraint 3.

15
To sum up:

Case

Different
O.F Value

1
2
3
4

2550819.67
2539130.43
2486956.52
2591019.24

Original
O.F Value

2486956.52
2486956.52
2486956.52
2486956.52

=
=
=
=

Increase in
Present
Value
63863.15
52173.91
0.00
104062.72

Case 4 generates the largest increase in Present Value.

5. $22,950.8197 out of the

the first year.

additional $100,000 should be allocated to

Capital allowed to Security Systems in 1st year= 600,000*0.35=$210,000

Capital allowed to Markey Analysis in 1st year=500,000*1.22=$610,000

16

Conclusion
Hart Venture Capital should allocate the available capital as below for
Security Systems and Market Analysis over 3 years:

Security
System Stock

Investment in Year 1

365,217.39

Investment in Year 2

365,217.39

Investment in Year 3

152,173.91

Market
Analysis
$
434,782.61
$
304,347.83
$
347,826.09

total
$

800,000.00

669,565.22

500,000.00

17
:
:

18

Reference cited
Anderson, David R., Dennis J. Sweeney, Thomas A, and Kipp Martin. An
Introduction to Management Science: Quantitative Approaches to Decision
Making. 12 ed. Ohio: Thomas South-Western, 2008

19