Professional Documents
Culture Documents
The
alternative investments are municipal bonds with an 8.5% annual return, certificates of deposit
with a 5% return, treasury bills with a 6.5% return, and a growth stock fund with a 13% annual
return. The investments are all evaluated after 1 year. However, each investment alternative has a
different perceived risk to the investor; thus, it is advisable to diversify. Kathleen wants to know
how much to invest in each alternative in order to maximize the return.
The following guidelines have been established for diversifying the investments and lessening
the risk perceived by the investor:
Decision Variables
Four decision variables represent the monetary amount invested in each investment alternative:
The objective of the investor is to maximize the total return from the investment in the four
alternatives. The total return is the sum of the individual returns from each alternative. Thus, the
objective function is expressed as
[Page 120]
maximize Z = $0.085 x 1 + 0.05 x 2 + 0.065 x 3 + 0.130 x 4
where
CAMP has had numerous reported applications around the world, including the
development of a 90-day planned menu cycle at a state hospital and planned menus for
schools that lower fat content while meeting nutritional requirements at a lower cost. In
general, mathematical programmingbased meal planning models have been formed to
reduce food costs by approximately 10% while meeting government-established
nutritional standards. Other traditional menu planning methods have generally not
achieved this level of success.
In this problem the constraints are the guidelines established for diversifying the total
investment. Each guideline is transformed into a mathematical constraint separately.
The first guideline states that no more than 20% of the total investment should be in municipal
bonds. The total investment is $70,000; 20% of $70,000 is $14,000. Thus, this constraint is
x1 $14,000
The second guideline indicates that the amount invested in certificates of deposit should not
exceed the amount invested in the other three alternatives. Because the investment in certificates
of deposit is x 2 and the amount invested in the other alternatives is x 1 + x 3 + x 4 , the constraint is
[Page 121]
x2 x 1+ x 3+ x 4
This constraint is not in what we referred to in Chapter 3 as standard form for a computer
solution. In standard form, all the variables would be on the left-hand side of the inequality
( ), and all the numeric values would be on the right side. This type of constraint can be
used in Excel just as it is shown here; however, for solution with QM for Windows, all
constraints must be in standard form. We will go ahead and convert this constraint and others in
this model to standard form, but when we solve this model with Excel, we will explain how the
model constraints could be used in their original (nonstandard) form. To convert this constraint
to standard form, x 1 + x 3 + x 4 must be subtracted from both sides of the sign to put this
constraint in proper form:
x 2x 1x 3x 4
Standard form requires all variables to be to the left of the inequality and numeric values to the
right .
The third guideline specifies that at least 30% of the investment should be in treasury bills and
certificates of deposit. Because 30% of $70,000 is $21,000 and the amount invested in
certificates of deposit and treasury bills is represented by x 2 + x 3 , the constraint is
x 2+ x 3 $21,000
The fourth guideline states that the ratio of the amount invested in certificates of deposit and
treasury bills to the amount invested in municipal bonds and the growth stock fund should be at
least 1.2 to 1:
[( x 2 + x 3 )/( x 1 + x 4 )] 1.2
This constraint is not in standard linear programming form because of the fractional relationship
of the decision variables, ( x 2 + x 3 )/( x 1 + x 4 ). It is converted as follows :
Finally, the investor wants to invest the entire $70,000 in the four alternatives. Thus, the sum of
all the investments in the four alternatives must equal $70,000:
x 1 + x 2 + x 3 + x 4 = $70,000
Model Summary
The complete linear programming model for this problem can be summarized as
The Excel spreadsheet solution for the investment example is shown in Exhibit 4.7, and its
Solver window is shown in Exhibit 4.8. The spreadsheet is set up very similarly to the
spreadsheet for our product mix example in Exhibit 4.1. The decision variables are located in
cells B13:B16 . The total return ( Z ) is computed in cell B17, and the formula for Z is shown on
the formula bar at the top of the spreadsheet. The constraint formulas for the investment
guidelines are embedded in cells H6 through H10. For example, the first guideline formula, in
cell H6, is = D6*B13 , and the second guideline formula, in cell H7, is
= D7*B13+E7*B14+F7*B15+G7*B16 . (Note that it would probably have been easier just to
type the guideline formulas directly into cells H6 through H10 rather than create the array of
constraint coefficients in D6:G10 ; however, for demonstration purposes, we wanted to show all
the parameter values.)
[Page 122]
Exhibit 4.7.
Exhibit 4.8.
As mentioned earlier, it is not necessary to convert the original model constraints into standard
form to solve this model using Excel. For example, the constraint for certificates of
[Page 123]
Solution Analysis
The solution is
Z = $6,818.18
The sensitivity report for our Excel spreadsheet solution to this problem is shown in Exhibit 4.9.
Exhibit 4.9.
Notice that the dual (shadow price) value for constraint 5 (i.e., the sum of the investments must
equal $70,000) is 0.095. This indicates that for each additional $1 Kathleen Allen invests (above
$70,000), according to the existing investment guidelines she has established, she could expect a
return of 9.5%. The sensitivity ranges show that there is no upper bound on the amount she could
invest and still receive this return.
An interesting variation of the problem is to not specify that the entire amount available (in this
case, $70,000) must be invested. This changes the constraints for the first and third guidelines
and the constraint that requires that the entire $70,000 be invested.
Recall that the first guideline is "no more than 20% of the total investment should be in
municipal bonds." The total investment is no longer exactly $70,000, but the sum of all four
investments, x 1 + x 2 + x 3 + x 4 . The constraint showing that the amount invested in municipal
bonds, x 1 , as a percentage (or ratio) of this total cannot exceed 20% is written as
Rewriting this constraint in a form more consistent with a linear programming solution (to
eliminate the fractional relationship between variables) results in
x1 0.2( x 1 + x 2 + x 3 + x 4 )
[Page 124]
and
The constraint for the third guideline, which stipulates that at least 30% of the total investment
( x 1 + x 2 + x 3 + x 4 ) should be in treasury bills and CDs ( x 2 + x 3 ), is formulated similarly as
and
Because the entire $70,000 does not have to be invested, the last constraint becomes
x 1+ x 2+ x 3+ x 4 70,000
[Page 125]
The solution to this altered model is exactly the same as the solution to our original model,
wherein the entire $70,000 must be invested. This is logical because only positive returns are
achieved from investing, and thus the investor would leave no money not invested. However, if
losses could be realized from some investments, then it might be a good idea to construct the
model so that the entire amount would not have to be invested.