More than Two Variables

Lecture 3
• Loan policy Model
• Thriftem bank is in the process of divesting a
loan policy that involves a maximum of $12
million. The following table provides the
pertinent data about available types of loan.

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Type of loan Interest rate Bad-debt ratio

Personal .140 .10

Car .130 .07
Home .120 .03
Farm .125 .05
Commercial .100 .02

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Bad debts are unrecoverable and produce no interest
revenue.

Competition with other financial institutions require that

the bank allocate at least 40% of the funds to farm and
commercial loans. To assist the housing industry in the
region, home loans must equal at least 50% of the
personal, car, and home loans. The bank also has a
stated policy of not allowing the overall ratio of bad
debts on all loans to exceed 4%.
• Required:
Device an optimal model for the bank

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Mathematical model
The situation seeks to determine the amount of loan in each category, thus
leading to the following definitions of the variables:
• X1 = Personal loans (in millions of dollars)
• X2 = car loan
• X3 = Home loans
• X4 = farm loans
• X5 = Commercial loans

• The object of the bank is to maximise its net return, the difference
between interest revenue and lost bad debt. The interest revenue is
accrued only on loans in good standing. Thus, because 10% of personal
loans are lost to bad debt, the bank will receive interest on only 90% of
the loan – that is, it will receive 14% interest on .9x1 of the original loan x1.
The same applies to the other four types of loans.

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Total interest = .14(.9X1) + .13(.93X2) + .12(.97X3) +
.125(.95X4) +.1(.98X5)
= .126X1 + .1209X2 + .1164X3 + .11875X4 + .098X5

Also Bad debt = .1X1 + .07X2 + .03X3 + .05X4 + .02X5

Objective function
Maximise Z = Total interest – bad debt
= (.126X1 + .1209X2 + .1164X3 + .11875X4 + .098X5) – (.1X1
+ .07X2 + .03X3 + .05X4 + .02X5)
= .026X1 + .0509X2 + .0864X3 + .06875X4 + .078X5

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Constrains
Total funds should not exceed $12 (milli0n)
X1 + X2 + X3 + X4 + X5  12
Farm and commercial loans equal at least 40% 0f all loans:
X4 + X5 ≥ .4(X1 + X2 + X3 + X4 + X5)
Or .4X1 + .4X2 +.4X3 -.6 X4 - .6X5  0
Home loans should equal at least 50% of personal, car and home loans:

X3 ≥ .5(X1 + X2 + X3)
Or .5X1 + .5X2 - .5 X3  0
Bad debts should not exceed 4% of all loans:
.1X1 + .07X2 + .03X3 + .05X4 + .02X5  .04(X1 + X2 + X3 + X4 + X5)
Or
.06X1 + .03X2 - .01 X3 + .01X4 -.02 X5  0

Non-negativity
X1 ≥ 0, X2 ≥ 0, X3 ≥ 0, X4 ≥ 0, X5 ≥ 0

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An important assumption in the formulation is that all
loans are issued at approximately the same time.
Allowing us to r ignore differences in the time value of
the funds allocated to the different loans.

Remarks:
In constraint no 2, the RH side can also be stated as .4 x
12 instead of .4(X1 + X2 + X3 + X4 + X5). However this
limits the situation to an exact value yet the optimal
situation might be where slightly less than $12M is
loaned out.

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 Production
• In preparation for the rain season, a clothing
company is manufacturing sweaters,
overcoats, Caps, and gloves. All products are
manufactured in four different departments:
Cutting, Insulating, Sewing and packaging. The
Company has received firm orders for its
products. The contract stipulates a penalty for
undelivered items. The following table
provides the pertinent data of the situation.
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 Time per Units (hrs)

Department Sweaters Overcoats Caps Gloves Capacity (hrs)

Cutting .30 .30 .25 .15 1000

Insulating .25 .35 .30 .10 1000

Sewing .45 .50 .40 .22 1000

Packaging .15 .15 .1 .05 1000

Demand 800 750 600 500

Unit profit $30 $40 $20 $10

Unit Penalty $15 $20 $10 $8

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Required:
Device a model for the optimal production for the company.

Mathematical Model:
Let
X1 be the number of Sweaters
X2 be the number of overcoats
X3 be the number of caps
X4 be the number of gloves
The company is penalized for not meeting demand. This means that
the objective of the problem is to maximise the net receipts e.g.
Net receipts = Total profit – Total penalty

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The total profit is expressed as 30X1 + 40X2 + 20X3 + 10X4.
The total penalty is a function of the shortage quantities ( demand –
units supplied of each product). These can be determined from the
limits:

X1  800, X2  750, X3  600, X4  500

A demand is not fulfilled if its constraint is satisfied as strict inequality.
The shortage of any product is expressed algebraically using
nonnegative variables as:
Sj = Number of shortage units of product j, j = 1, 2, 3, 4
The demand constraints are then written as:
X1 + S1 = 800, X2 +S2 = 750, X3 +S3 = 600, X4 +S4 = 500
Xj ≥ 0, Sj ≥ 0, j = 1, 2, 3, 4

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The shortage penalty is then computed as:
15S1 + 20S2 + 10S3 + 8S4, thus the objective function
is written as:
Maximise 30X1 +40X2 + 20X3 + 10X4 – (15S1 + 20S2
+10S3 +8S4)
Production capacity restrictions include:
.30X1 +.30X2 + .25X3 + .15X4  1000 (cutting)
.25X1 +.35X2 + .30X3 + .10X4  1000 (Insulating)
.45X1 +.50X2 + .40X3 + .22X4  1000 (Sewing)
.15X1 +.15X2 + .10X3 + .05X4  1000 (packaging)
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Complete model:
Maximise 30X1 +40X2 + 20X3 + 10X4 – (15S1 + 20S2
+10S3 +8S4)
Subject to:
.30X1 +.30X2 + .25X3 + .15X4  1000
.25X1 +.35X2 + .30X3 + .10X4  1000
.45X1 +.50X2 + .40X3 + .22X4  1000
.15X1 +.15X2 + .10X3 + .05X4  1000
X1 + S1 = 800, X2 +S2 = 750, X3 +S3 = 600, X4 +S4 = 500
Xj ≥ 0, Sj ≥ 0, j = 1, 2, 3, 4
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• Toolco has contracted with AutoMate to supply
their automotive discount stores with wrenches
and chisels. AutoMate’s weekly demand consists
of at least 1500 wrenches and 1200 chisels.
Toolco cannot produce all the requested units
with its present one-shift capacity and must use
overtime and possibly subcontract with other
tool shops. The result is an increase in the
production cost per unit, as shown in the
following table. Market demand restricts the ratio
of chisels to wrenches to at least 2:1.

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Tool Production type Weekly production Unit cost ($)
range(units)

Wrenches Regular 0-550 2.00

Overtime 551-800 2.80
Subcontracting 801 -∞ 3.00

Chisel Regular 0-620 2.10

Overtime 621-900 3.20
Subcontracting 901-∞ 4.20

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• Required
I. Formulate the problem as a linear program,
and determine the optimum production
schedule for each tool.
II. Relate the fact that the production cost
function increasing unit costs to the validity
of the model.

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