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Chapter 5: Network Design in the Supply Chain

Exercise Solutions

1.
(a)
The objective of this model is to decide optimal locations of home offices, and number of trips
from each home office, so as to minimize the overall network cost. The overall network cost is a
combination of fixed costs of setting up home offices and the total trip costs.

There are two constraint sets in the model. The first constraint set requires that a specified
number of trips be completed to each state j and the second constraint set prevents trips from a
home office i unless it is open. Also, note that there is no capacity restriction at each of the home
offices. While a feasible solution can be achieved by locating a single home office for all trips to
all states, it is easy to see that this might not save on trip costs, since trip rates vary between home
offices and states. We need to identify better ways to plan trips from different home offices to
different states so that the trip costs are at a minimum. Thus, we need an optimization model to
handle this.

Optimization model:
n = 4: possible home office locations.
m = 16: number of states.
Dj = Annual trips needed to state j
Ki = number of trips that can be handled from a home office
As explained, in this model there is no restriction
fi = Annualized fixed cost of setting up a home office
cij = Cost of a trip from home office i to state j
yi = 1 if home office i is open, 0 otherwise
xij = Number of trips from home office i to state j.
It should be integral and non-negative
n n m
Min  f y   c x
i 1
i i
i 1 j 1
ij ij

Subject to
n

x
i 1
ij  D j for j  1,...,m (5.1)
m

x
j1
ij  K i yi for i  1,...,n (5.2)

yi  {0,1} for i  1,...n (5.3)

Please note that (5.2) is not active in this model since K is as large as needed. However, it will be used in answering
(b).

1
 SYMBOL INPUT CELL
Dj Annual trips needed to state j E7:E22
G7:G22,I7:I22,
cij Transportation cost from office i to state j
K7:K22,M7:M22
fixed cost of setting up office i
fi G26,I26,K26,M26
F7:F22,H7:H22,
xij number of consultants from office i to state j.
J7:J22,L7:L22
obj. objective function M31
5.1 demand constraints N7:N22
(Sheet SC consulting in workbook exercise5.1.xls)

2
With this we solve the model to obtain the following results:

Trip
Tot Trip s Trips Trips
al # s from Cost from Cost from Cost
of from Cost Tuls from Denve From Seattl from
State trips LA from LA a Tulsa r Denver e Seattle

Washington 40 - 150 - 250 - 200 40 25

Oregon 35 - 150 - 250 - 200 35 75

California 100 100 75 - 200 - 150 - 125

Idaho 25 - 150 - 200 - 125 25 125

Nevada 40 40 100 - 200 - 125 - 150

Montana 25 - 175 - 175 - 125 25 125

Wyoming 50 - 150 - 175 50 100 - 150

Utah 30 - 150 - 150 30 100 - 200

Arizona 50 50 75 - 200 - 100 - 250

Colorado 65 - 150 - 125 65 25 - 250

New Mexico 40 - 125 - 125 40 75 - 300

North Dakota 30 - 300 - 200 30 150 - 200

South Dakota 20 0 300 - 175 20 125 - 200

Nebraska 30 - 250 30 100 - 125 - 250

Kansas 40 - 250 25 75 15 75 - 300

Oklahoma 55 - 250 55 25 - 125 - 300

# of trips 675 190 - 110 - 250 - 125

# of Consultants 8 5 10 5
Fixed Cost of
office 165,428 131,230 140,000 145,000

Cost of Trips   15,250 6,250 20,750 9,875

Total Office Cost     180,678   137,480   160,750   154,875

The number of consultants is calculated based on the constraint of 25 trips per consultant. As
trips to Kansas cost the same from Tulsa or Denver there are many other solutions possible by
distributing the trips to Kansas between these two offices.

3
(b)
If at most 10 consultants are allowed at each home office, then we need to add one more
constraint i.e. the total number of trips from an office may not exceed 250. Or in terms of the
optimization model, Ki, for all i, should have a value of 250. We can revise constraint (5.2) with
this Ki value and resolve the model. The new model will answer (b).

However in this specific case, it is clear that only the Denver office violates this new condition.
As trips to Kansas can be offloaded from Denver to Tulsa without any incremental cost, that is a
good solution and still optimal.

Hence we just allocate 5 of the Denver-Kansas trips to Tulsa. This reduces the number of
consultants at Denver to 10 while maintaining 5 consultants at Tulsa.

(c)
Just like the situation in (b), though in general we need a new constraint to model the new
requirement, it is not necessary in this specific case. We note that in the optimal solution of (b),
each state is uniquely served by an office except for Kansas where the load is divided between
Denver and Tulsa. The cost to serve Kansas is the same from either office. Hence we can meet
the new constraint by making Tulsa fully responsible for Kansas. This brings the trips out of
Tulsa to 125 and those out of Denver to 235. Again the number of consultants remains at 5 and
10 in Tulsa and Denver, respectively.

2.
DryIce Inc. faces the tradeoff between fixed cost (that is lower per item in a larger plant) versus
the cost of shipping and manufacturing. The typical scenarios that need to be considered are
either having regional manufacturing if the shipping costs are significant or have a centralized
facility if the fixed costs show significant economies to scale.

We keep the units shipped from each plant to every region as variable and choose the fixed cost
based on the emerging production quantities in each plant location. The total system cost is then
minimized with the following constraints:

a. All shipment numbers need to be positive integers.

b. The maximum production capacity is 400,000
c. All shipments to a region should add up to the requirement for 2006 .

Optimization model:
n = 4: potential sites.
m = 4: number of regional markets.
Dj = Annual units needed of regional market j
Ki = maximum possible capacity of potential sites.
Each Ki is assigned value 400000. If actually needed
capacity is less than or equal to 200000, we choose fixed cost accordingly.
fi = Annualized fixed cost of setting up a potential site.
cij = Cost of producing and shipping an air conditioner from site i to regional market j
yi = 1 if site i is open, 0 otherwise
xij = Number of air conditioners from site i to regional market j.

4
 It should be integral and non-negative
n n m
Min  f y   c x
i 1
i i
i 1 j 1
ij ij

Subject to
n

x
i 1
ij  D j for j  1,...,m (5.1)
m

x
j1
ij  K i yi for i  1,...,n (5.2)

SYMBOL INPUT CELL

Dj requirement at market j K10:K13
C10:C13,E10:E13
cij Variable cost from plant i to market j
G10:G13,I10:I13
fixed cost of setting up plant i C7:C8,E7:E8
fi
G7:G8,I7:I8
D10:D13,F10:F13
xij number of consultants from office i to state j.
H10:H13,J10:J13
obj. objective function K21
5.1 demand constraints L10:L13
(Sheet DryIce in workbook exercise5.2.xls)

We get the following results:

The optimal solution suggests setting up 4 regional plants with each serving the needs of its own
region. New York, Atlanta, Chicago and San Diego should each have a 200,000 capacity plant
with production levels of 110000, 180000, 120000, 100000, respectively.

3
(a)
Sunchem can use the projections to build an optimization model as shown below. In this case, the
shipments from each plant to every market are assumed to be variable and solved to find the
minimum total cost. This is done by utilizing the following constraints:

 Each plant runs at least at half capacity.

 Sum of all shipments from the plant needs to be less than or equal to the capacity in that
plant.
 All production volumes are non-negative.
 All calculations are performed at the exchange rates provided.

5
Optimization model:
n = 5: five manufacturing plants
m = 5: number of regional markets.
Dj = Annual tons of ink needed for regional market j
Ki = Maximum possible capacity of manufacturing plants.
Especially for (a) lower limit for capacity is 50%*Ki .
cij = Cost of shipping one ton of printing ink from plant i to regional market j
pi = Cost of producing one ton of printing ink at plant i
xij = Tons of printing ink shipped from site i to regional market j.
It should be integral and non-negative
n m
Min  (c
i 1 j 1
ij  pi ) xij

Subject to
n

x
i 1
ij  D j for j  1,...,m (5.1)
m

x
j1
ij  K i for i  1,...,n (5.2)

x
j1
ij  0.5 K i for i  1,...,n (5.3)

SYMBOL INPUT CELL

Dj Annual demand at market j N4:N8
D4:D8,F4:F8,H4:H8,
cij shipping cost from plant i to regional market j
J4:J8, L4:L8
production cost of at plant i
pi D12,F12,H12,J12,L12
E4:E8,G4:G8,I4:I8,
xij printing ink shipped from site i to regional market j
K4:K8, M4:M8
obj. objective function N18
5.1 demand constraints O4:O8
5.2 capacity constraints E10,G10,I10,K10,M10
5.3 50% capacity constraints E10,G10,I10,K10,M10
(Sheet capacity_constraints in workbook exercise5.3.xls)

The optimal result is summarized in the following table:

US ShipmentGermany Shipment
Japan Shipment Brazil Shipment India Shipment Demand(ton/yr)
N. America 600 100 1,300 160 2,000 - 1,200 10 2,200 - 270 -
S. America 1,200 - 1,400 - 2,100 - 800 190 2,300 - 190 0
Europe 1,300 - 600 200 1,400 - 1,400 - 1,300 - 200 -
Japan 2,000 - 1,400 95 300 25 2,100 - 1,000 - 120 0
Asia 1,700 - 1,300 20 900 - 2,100 - 800 80 100 -
Capacity (ton/yr) 185 100 475 475 50 25 200 200 80 80
Minimum Run Rate 93 238 25 100 40
$ Mark Yen Real Rs.
Production Cost per Ton 10,000 15,000 1,800,000 13,000 400,000
Exch Rate 1.000 0.502 0.009 0.562 0.023
Prod Cost per Ton(US$) 10,000 7,530 16,740 7,306 9,200
Production Cost In US$ 1,000,000 3,576,750 418,500 1,461,200 736,000
Tpt Cost in US$ 60,000 487,000 7,500 164,000 64,000

Total 1,060,000 4,063,750 426,000 1,625,200 800,000 7,974,950

6
This is clearly influenced by the production cost per ton and the local market demand. Low cost
structure plants need to operate at capacity.

(b)

If there are no limits on production we can perform the same exercise as in (a) but without the
capacity constraints (5.2) and (5.3). This gives us the following results:
US ShipmentGermany Shipment
Japan Shipment Brazil Shipment India Shipment Demand(ton/yr)
N. America 600 - 1,300 - 2,000 - 1,200 270 2,200 - 270 -
S. America 1,200 - 1,400 - 2,100 - 800 190 2,300 - 190 0
Europe 1,300 - 600 200 1,400 - 1,400 - 1,300 - 200 -
Japan 2,000 - 1,400 120 300 - 2,100 - 1,000 - 120 0
Asia 1,700 - 1,300 100 900 - 2,100 - 800 - 100 -
Capacity (ton/yr) 185 - 475 420 50 - 200 460 80 -
Minimum Run Rate 93 238 25 100 40
$ Mark Yen Real Rs.
Production Cost per Ton 10,000 15,000 1,800,000 13,000 400,000
Exch Rate 1.000 0.502 0.009 0.562 0.023
Prod Cost per Ton(US$) 10,000 7,530 16,740 7,306 9,200
Production Cost In US$ - 3,162,600 - 3,360,760 -
Tpt Cost in US$ - 418,000 - 476,000 -

Total - 3,580,600 - 3,836,760 - 7,417,360

Clearly by having no restrictions on capacity SunChem can reduce costs by $557,590. The
analysis shows that there are gains from shifting a significant portion of production to Brazil and
having no production in Japan, US and India.

(c)
From the scenario in (a) we see that two of the plants are producing at full capacity. And in (b),
we see that it is more economical to produce higher volumes in Brazil. Once we add 10 tons/year
to Brazil, the cost reduces to $7,795,510.
US ShipmentGermany Shipment
Japan Shipment Brazil Shipment India Shipment Demand(ton/yr)
N. America 600 115 1,300 135 2,000 - 1,200 20 2,200 0 270 (0)
S. America 1,200 - 1,400 - 2,100 - 800 190 2,300 - 190 -
Europe 1,300 - 600 200 1,400 - 1,400 - 1,300 - 200 -
Japan 2,000 - 1,400 120 300 - 2,100 - 1,000 - 120 -
Asia 1,700 - 1,300 20 900 - 2,100 - 800 80 100 -
Capacity (ton/yr) 185 115 475 475 50 - 210 210 80 80
Minimum Run Rate 93 238 25 105 40
$ Mark Yen Real Rs.
Production Cost per Ton 10,000 15,000 1,800,000 13,000 400,000
Exch Rate 1.000 0.502 0.009 0.562 0.023
Prod Cost per Ton(US$) 10,000 7,530 16,740 7,306 9,200
Production Cost In US$ 1,150,000 3,576,750 - 1,534,260 736,000
Tpt Cost in US$ 69,000 489,500 - 176,000 64,000

Total 1,219,000 4,066,250 - 1,710,260 800,000 7,795,510

(d)
It is clear that fluctuations in exchange rates will change the cost structure of each plant. If the
cost at a plant becomes too high, there is merit in shifting some of the production to another plant.
Similarly if a plant’s cost structure becomes more favorable, there is merit in shifting some of the
production from other plants to this plant. Either of these scenarios requires that the plants have
built in excess capacity. Sunchem should plan on making excess capacity available at its plants.

7
4
(a)
Starting from the basic models in (a), we will build more advanced models in the subsequent
parts of this question. Prior to merger, Sleekfon and Sturdyfon operate independently, and so we
need to build separate models for each of them.

Optimization model for Sleekfon:

n = 3: Sleekfon production facilities.
m = 7: number of regional markets.
Dj = Annual market size of regional market j
Ki = maximum possible capacity of production facility i
cij = Variable cost of producing, transporting and duty from facility i to market j
fi = Annual fixed cost of facility i
xij = Number of units from facility i to regional market j.
It should be integral and non-negative.
n n m
Min i 1
f i   cij xij
i 1 j 1

Subject to
n

x i 1
ij  D j for j  1,...,m (5.1)
m

x j1
ij  K i for i  1,...,n (5.2)

Please note that we need to calculate the variable cost cij before we plug it into the optimization
model. Variable cost cij is calculated as follows:
cij = production cost per unit at facility i + transportation cost per unit from facility i to market j
+ duty*( production cost per unit at facility i + transportation cost per unit from facility i to
market j + fixed cost per unit of capacity)

SYMBOL INPUT CELL

Dj Annual market size of regional market j B4:H4
Ki maximum possible capacity of production facility i C12:C14
cij Variable cost of producing, transporting and duty from facility i to market j B22:H28
Annual fixed cost of facility i
fi D12:D17
xij Number of units from facility i to regional market j. C43:I45
obj. objective function D48
5.1 demand constraints J43:J45
5.2 capacity constraints C46:I46
(Sheet sleekfon in workbook problem5.4)

The above model gives optimal result as in following table:

8
 N. S. Europe Europe Japan Rest of Africa Capacity
Quantity Shipped America America (EU) (Non EU) Asia/Australia

Europe
(EU) 0.00 0.00 20.00 0.00 0.00 0.00 0.00 0.00
Sleekfon N.
America 10.00 0.00 0.00 3.00 2.00 2.00 0.00 3.00
S.
America 0.00 4.00 0.00 0.00 0.00 0.00 1.00 5.00
Demand 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Total Cost for Sleekfon = $ 564.39

And we use the same model but with data from Sturdyfon to get following optimal production
and distribution plan for Sturdyfon:

N. S. Europe Europe Japan Rest of Africa Capacity

Quantity Shipped America America (EU) (Non EU) Asia/Australia

Europe
(EU) 0.00 0.00 4.00 8.00 0.00 0.00 1.00 7.00
Sturdyfon N.
America 12.00 1.00 0.00 0.00 0.00 0.00 0.00 7.00
Rest of
Asia 0.00 0.00 0.00 0.00 7.00 3.00 0.00 0.00
Demand 0 0 0 0 0 0 0

Total cost for Sturdyfon = 512.68

(b)

Under conditions of no plant shutdowns, the previous model is still applicable. However, we need
to increase the number of facilities to 6, i.e., 3 from Sleekfon and 3 from Sturdyfon. And the
market demand at a region needs revised by combining the demands from the two companies.
Decision maker has more facilities and greater market share in each region, and hence has more
choices for production and distribution plans. The optimal result is summarized in the following
table.

9
 N. S. Europe Europe Japan Rest of Africa Capacity
America America (EU) (Non EU) Asia/Australia

Europe
(EU) 0.00 0.00 4.00 11.00 0.00 0.00 2.00 3.00
Sleekfon N.
America 16.00 0.00 0.00 0.00 4.00 0.00 0.00 0.00
S.
America 0.00 5.00 0.00 0.00 0.00 0.00 0.00 5.00
Europe
(EU) 0.00 0.00 20.00 0.00 0.00 0.00 0.00 0.00
Sturdyfon N.
America 6.00 0.00 0.00 0.00 0.00 0.00 0.00 14.00
Rest of
Asia 0.00 0.00 0.00 0.00 5.00 5.00 0.00 0.00
Demand 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Total Cost for Merged Network = 1066.82

(c)

This model is more advanced since it allows facilities to be scaled down or shutdown.
Accordingly we need more variables to reflect this new complexity.

Optimization model for Sleekfon:

n = 6: Sleekfon and Sturdyfon production facilities.
m = 7: number of regional markets.
Dj = Annual market size of regional market j, sum of the Sleekfon and Sturdyfon market share.
Ki =capacity of production facility i
Li =capacity of production facility if it is scaled back
cij = Variable cost of producing, transporting and duty from facility i to market j
fi = Annual fixed cost of facility i
gi = Annual fixed cost of facility i if it is scaled back
hi = Shutdown cost of facility i
xij = Number of units from facility i to regional market j.
It should be integral and non-negative.
yi = Binary variable indicating whether to scale back facility i. y i = 1 means to scale it back, 0
otherwise.
Since two facilities, Sleekfon S America and Sturdyfon Rest of Asia, can not be scaled back, the
index i
doesn’t include these two facilities.
zi = Binary variable indicating whether to shutdown facility i. zi =1 means to shutdown it, 0 otherwise.
(1-yi –zi) would be the binary variable indicating whether the facility is unaffected.

10
 n n m
Min  ( f (1  y
i 1
i i  zi )  gi yi  hi zi )   cij xij
i 1 j 1

Subject to
n

x
i 1
ij  D j for j  1,..., m (5.1)
m

x
j 1
ij  K i (1  yi  zi )  Li yi for i  1,..., n (5.2)

1  yi  zi  0 for i  1,..., n (5.3)

yi , zi are binary for i  1,..., n (5.4)

Please note that we need to calculate the variable cost cij before we plug it into the optimization
model. Variable cost cij is calculated as following:
cij = production cost per unit at facility i + transportation cost per unit from facility i to market j
+ duty*( production cost per unit at facility i + transportation cost per unit from facility i to
market j + fixed cost per unit of capacity)

And we also need to prepare fixed cost data for the two new scenarios: shutdown and scale back.
As explained in the problem description, fixed cost for a scaled back facility is 70% of the
original one; and it costs 20% of the original annual fixed cost to shutdown it.

Above model gives optimal solution as summarized in the following table. The lowest cost
possible in this model is $988.93, much lower than the result we got in (b) $1066.82. As shown in
the result, the Sleekfon N.America facility is shutdown, and the market is mainly served by
Sturdyfon N.America facility. The N.America market share is 22, and there are 40 in terms of
production capacity, hence it is wise to shutdown one facility whichever is more expensive.

N. S. Europe Europe Japan Rest of Africa Scale back Shut down Plant Capacity
Quantity Shipped America America (EU) (Non EU) Asia/Australia unaffected

Europe
(EU) 0.00 0.00 5.00 11.00 0.00 0.00 2.00 0.00 0.00 1.00 2.00
Sleekfon N.
America 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00 0.00
S.
America 2.00 5.00 0.00 0.00 3.00 0.00 0.00 0 0.00 1.00 0.00
Europe
(EU) 0.00 0.00 19.00 0.00 1.00 0.00 0.00 0.00 0.00 1.00 0.00
Sturdyfon N.
America 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00 0.00 0.00
Rest of
Asia 0.00 0.00 0.00 0.00 5.00 5.00 0.00 0.00 0.00 1.00 0.00
Demand 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Total Cost for Merged Network = 988.93

For questions (d) and (e), we need to change the duty to zero and run the optimization model
again to get the result. We can achieve this by resetting B7:H7 to zeros in sheet merger
(shutdown) in workbook problem5.4.xls.

11
5
(a)
The model we developed in 4.d is applicable to this question. We only need to update the demand
data accordingly. And the new demand structure yields a quite different optimal configuration of
the network.
N. S. Europe Europe Japan Rest of Africa Scale back Shut down Plant Small Large Capacity
Quantity Shipped America America (EU) (Non EU) Asia/Australia unaffected addition Addition

Europe
(EU) 0.00 0.00 20.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00 0.00
Sleekfon N.
America 15.60 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00 4.40
S.
America 0.00 6.00 0.00 0.00 0.00 0.00 0.00 0 0.00 1.00 4.00
Europe
(EU) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00 0.00 0.00
Sturdyfon N.
America 6.40 0.00 4.00 9.60 0.00 0.00 0.00 0.00 0.00 1.00 0.00
Rest of
Asia 0.00 0.00 0.00 3.60 9.00 15.00 2.40 0.00 0.00 1.00 0.00 1.00 0.00
Demand 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00

Total Cost for Merged Network 1141.77

As shown in the table, Sturdyfon N.America is not shutdown in this optimal result. Instead,
Sturdyfon EU facility is shutdown.

For questions (b), (c) and (d), we need to update Excel sheet data accordingly and rerun the
optimization model.

6
(a)

StayFresh faces a multi-period decision problem. If we treated each period separately, only two
constraints are relevant, i.e., the demand and capacity constraints. Considering the multi-period
nature of this problem, it must be noted that as the demand increases steadily, we need to add
capacities eventually. However due to the discount factor, we want to increase capacities as late
as possible. On the other hand, even when the total capacity at a certain period is greater than or
equal to the total demand, we might want to increase capacity anyway. This is because a regional
market might run short while the total supply is surplus, and it may be more expensive to ship
from other regions than to increase local capacity. This complexity calls for an optimization
model to find an optimal solution which can serve all demands, satisfy capacity constraints,
adjust the regional imbalance, and take benefit of discount effect over periods.

12
I: set of plants and potential plants
J: set of regional markets
T: set of periods under consideration. 6~10 year is treated separately. And T  5 in this model.
K: set of capacity incremental options
d jt : demand of regional market j at period t
M i : capacity of plant i at beginning
cij : production and transportation cost from plant i to reginal market j
e k : capacity increment amount of option k
f k : capacity increment cost of option k
r : discount factor
Yikt : binary variable. 1 means to increase capacity of plant i using option k at time t; 0 otherwise.
X ijt : decision variable, shipment amount from plant i to market j at time t

  10  
Min t 
 x c
ijt ij   f y
k ikt  /( 1  r)t
    xij 5cij   f k yik 5  /( 1  r)
t

 i j i k  t 5  i j i k 
 xijt M i   yikt ek for each plant i at each period t
j t
5.1

x
i
ijt  dj for each regional market j 5.2

xijt  0 , binary yikt for all plant, market, period, and capacity incremental options

13
 SYMBOL INPUT CELL
d jt demand of regional market j at period t B9:H9
Mi capacity of plant i at beginning C12:C14
cij Production and transportation cost from plant i to regional market j B5:F8
ek capacity increment amount of option k D12:D17
fk capacity increment cost of option k C43:I45
r discount factor D48
Yikt binary variable. 1 means to increase capacity of plant i using option k at time t; 0 otherwise I5:Q8
B22:E25
H22:K25
X ijt decision variable, shipment amount from plant i to market j at time t N22:Q25
T22:W25
Z22:AC25
obj objective function C31
G22:G25
M22:M25
5.1 capacity constraint S22:S25
Y22:Y25
Ae22:Ae25
B26:E26
H26:K26
5.2 demand constraint N26:Q26
T26:W26
Z26:AC26
(Sheet StayFresh in workbook problem5.6.xls)

In the first year, original total capacity was 600,000 units, which was 60,000 units more than the
total demand. However, a new plant in Kolkata is built in the optimal solution anyway, since it is
cheaper to server the local market from Kolkata than to ship from other regions.

In the second year, no new capacity is added, since the plant location is reasonable and the total
capacity still exceeds the demand.

In the third and fourth years, new capacity is added consecutively, which has lead to high surplus
capacity. Note that this additional capacity is needed for the fifth year. While there is no reason to
add capacity earlier than necessary, especially under the consideration of the discount factor, the
solution is optimal in this particular model. Since the cost of fifth year will be added into the
total cost six times, it is strategically correct to spend as little as possible in the fifth year. This
explains why extra capacity is built into the network earlier than necessary.

For questions (b) and (c), we need to change data in the Excel sheet accordingly.

7
(a)

14
Blue Computers has two plants in Kentucky and Pennsylvania, however both have high variable
costs to serve the West regional market. On the other hand, West regional market has 2 nd highest
demand. Hence it is not hard to see that Blue Computers needs a new plant, which can serve the
West regional market at a lower cost. From this point of view, California is a better choice than
N.Carolina since California has a lower variable cost serving West regional market. However,
N.Carolina has extra tax benefit. Even if a network of Kentucky, Pennsylvania, and California
might yield higher before-tax profit than a network of Kentucky, Pennsylvania, and N.Carolina,
the after-tax profit might be worse.

n = 2 potential sites.
m = 4: number of regional markets.
Dj = Annual units needed of regional market j
Ki = maximum possible capacity of potential sites.
fi = Annualized fixed cost of setting up a potential site.
cij = Cost of producing and shipping a computer r from site i to regional market j
yi = 1 if site i is open, 0 otherwise
xij = Number of products from site i to regional market j.
It should be integral and non-negative
n n m
Min i 1
f i yi   cij xij
i 1 j 1

Subject to
n

x
i 1
ij  D j for j  1,..., m (5.1)
m

x
j 1
ij  K i yi for i  1,..., n (5.2)

y3  y4  1 add at most one site (5.3)

y3 , y4 are binary (5.4)

SYMBOL INPUT CELL

Dj Annual market size of regional market j B9:F9
Ki maximum possible capacity of production facility i H5:H8
cij Variable cost of producing, transporting and duty from facility i to market j B5:F8
Annual fixed cost of facility i
fi G5:G8
xij Number of units from facility i to regional market j. B17:F20
obj. objective function I21
5.1 demand constraints B21:F21
5.2 capacity constraints H17:H20
5.4 see explanation in next paragraph
(Sheet Blue in workbook problem5.7.xls)

Even though constraint (5.4) is simple in its mathematical notation, we can do better in practice.
Since at most one site can be open, we can run the optimization three times for three scenarios
respectively: none open, only California, or only N.Carolina. And we compare the three results
and choose the best one. It is much faster to solve these three scenarios separately given that

15
EXCEL solver cannot achieve a converging result with constraint (5.4). The result below shows
the optimal solution when California is picked up.

Shipment Northeast Southeast Midwest South West Open (1) / Capacity Cost
Shut (0) Constraint
Kentucky 0 0 600 0 0 1 400.00 $ 255,000
Pennsylvania 0 150 2.43E-09 450 900 1 0.00 $ 516,500
N. Carolina 0 0 0 0 0 1.00 1500.00 $ 200,000
California 1050 450 0 0 0 1 0.00 $ 530,000
Demand -2.65E-06 -1.5E-06 5.01E-10 -1.1E-06 -2.3E-06
constraint Total Cost = 1501500

(b)
We only need to change the objective function from minimize cost to maximize profit. On the
Excel sheet, all we need to do is to set the target cell from I21 to L21, and change the direction of
optimization from minimizing to maximizing. The following table shows the result. It is easy to
see that lowest cost doesn’t mean maximum after tax profit.
Shipment Northeast Southeast Midwest South West Open (1) / Capacity Cost Revenue Profit After tax
Shut (0) Constraint profit
Kentucky 0 600 0 400 0 1 0.00 $ 328,000 $ 1,000,000 $ 672,000 $ 490,560
Pennsylvania 1050 0 450 0 0 1 0.00 $ 459,500 $ 1,500,000 $ 1,040,500 $ 759,565
N. Carolina 0 0 0 0 0 0.00 0.00 $ 0 $ - $ (0) $ (0)
California 0 0 150 50 900 1 400.00 $ 396,500 $ 1,100,000 $ 703,500 $ 513,555
Demand -2.65E-06 -1.5E-06 -1.5E-06 -1.1E-06 -2.3E-06
constraint Total Cost = 1184000 Total Profit = $ 1,763,680

8
(a)
Starting from the basic models in (a), we will build more advanced models in the subsequent
parts of this question. Prior to merger, Hot&Cold and CaldoFreddo operate independently, and
we need to build separate models for each of them.

Optimization model for Hot&Cold:

n = 3: Hot&Cold production facilities.
m = 4: number of regional markets.
Dj = Annual market size of regional market j
Ki = maximum possible capacity of production facility i
cij = Variable cost of producing, transporting and duty from facility i to market j
fi = Annual fixed cost of facility i
ti =Tax rate at facility i
xij = Number of units from facility i to regional market j.
It should be integral and non-negative.

16
 n n m
Min  f   c x
i 1
i
i 1 j 1
ij ij

Subject to
n

x
i 1
ij  D j for j  1,...,m (5.1)
m

x
j1
ij  K i for i  1,...,n (5.2)

And replace above objective function to the following one to maximize after tax profit:
n m n n m
Max  (1  t ) px   f   c x
i 1
i
j 1
ij
i 1
i
i 1 j 1
ij ij

SYMBOL INPUT CELL

Dj Annual market size of regional market j C8:F8
Ki maximum possible capacity of production facility i G5:G7
cij Variable cost of producing, transporting and duty from facility i to market j C5:F7
Annual fixed cost of facility i
fi H5:H7
xij of units from facility i to regional market j. C20:F22
obj. objective function H24
5.1 demand constraints C23:F23
5.2 capacity constraints G20:G22
(Sheet Hot&Cold in workbook problem5.8.xls)

The above model gives optimal result as in following table:

Shipment North East South West Capacity Annual

Cost
Hot&Cold France 0.0 0.0 15.0 35.0 0 6150
Germany 10.0 0.0 5.0 0.0 35 2475
Finland 20.0 20.0 0.0 0.0 0 4650
Demand 0 0 0 0
Total Cost 13275

And we use the same model but with data from CaldoFreddo to get following optimal production
and distribution plan for CaldoFreddo:

Capacity Annual Cost

Shipment
Quantity Shipped (million units)
CaldoFreddo U.K. 15 15 0 20 0 $ 6,175
Italy 0 5 30 0 25 $ 4,225
Demand 0 0 0 0
Total Cost $ 10,400

17
(b)

If none of the plants is shut down, the previous model is still applicable. However, we need to
update the number of facilities to 5, with 3 from Hot&cold and 2 from CaldoFreddo. And we
need to update the market demand Dj, which should be the sum of market shares. Decision maker
has more facilities and greater market share in each region, and hence has more choices for
production and distribution plans. The optimal result is summarized in the following table.

Open (1) / Capacity Annual

Shipment
Quantity Shipped (million units) Shut (0) Cost
Merged France 0 0 0 5 1 45 $ 1,500
Company Germany 30 0 0 0 1 20 $ 3,850
Finland 15 25 0 0 1 7.9492E-09 $ 4,700
U.K. 0 0 0 50 1 0 $ 5,500
Italy 0 10 50 0 1 0 $ 6,450
Demand 1.3E-10 -9.8E-09 0.0E+00 -1.9E-09
$ 22,000

(c)

This model is more advanced since it allows facilities to be shutdown. Accordingly we need more
variables to reflect this new complexity.

Optimization model for Sleekfon:

n = 5: Hot&Cold and caldoFreddo production facilities.
m = 4: number of regional markets.
Dj = Annual market size of regional market j, sum of the : Hot&Cold and caldoFreddo market share.
Ki =capacity of production facility i
cij = Variable cost of producing, transporting and duty from facility i to market j
fi = Annual fixed cost of facility i
xij = Number of units from facility i to regional market j.
It should be integral and non-negative.
zi = Binary variable indicating whether to shutdown facility i. zi =1 means to shutdown it, 0 otherwise.

n n m
Min  f (1  z )   c x
i 1
i i
i 1 j 1
ij ij

Subject to
n

x
i 1
ij  D j for j  1,..., m (5.1)
m

x
j 1
ij  K i (1  zi ) for i  1,..., n (5.2)

zi are binary for i  1,..., n (5.3)

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 SYMBOL INPUT CELL
Dj Annual market size of regional market j C8:F8
Ki maximum possible capacity of production facility i C12:C14
cij Variable cost of producing, transporting and duty from facility i to market j C5:F7
Annual fixed cost of facility i
fi H5:H7
xij Number of units from facility i to regional market j. C19:F23
Zi open or shutdown facility i G19:G23
obj. objective function I25
5.1 demand constraints C24:F24
5.2 capacity constraints H19:H23
(Sheet Merged in workbook problem5.8.xls)

It turned out that all sites are open so as to achieve best objective value. Following table shows
the optimal configuration.

Open (1) / Capacity Annual

Shipment
Quantity Shipped (million units) Shut (0) Cost
Merged France 0 0 0 5 1 45 $ 1,500
Company Germany 40 0 0 0 1 10 $ 4,800
Finland 5 35 0 0 1 0 $ 4,800
U.K. 0 0 0 50 1 0 $ 5,500
Italy 0 0 50 0 1 10 $ 5,400
Demand 0.0 0.0 0.0 0.0
Total Cost $ 22,000

19