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Case Summary

y y SUZ is a truck manufacturing company The company during the six month period of January to June 2008 has had a bad financial performance due to which the company¶s president expressed his dissatisfaction at the monthly planning meeting with controller, sales and production managers July 2008. y The company has been producing 2 models of trucks 101 and 102 in a single plant at Wheeling, Michigan y Various opinions are placed across the table in the meeting by the managers as a solution to the problem placed by the president ,some of which are as follows: o Changing the Product mix o Purchasing engines from an outside supplier o Relieving the capacity in the engine assembly department y The manufacturing operations for trucks had been divided into four departments: engine assembly, metal stamping, Model1 assembly, Model 2 assembly. y Capacity of each department is expressed as the manufacturing machine hours available . y The output in the 1st 6 months of 2008 had been 1000 Model 101 and 1500 Model 102,at this level the engine assembly and Model 102 assembly capacities were completely utilized, whereas that of metal stamping and Model 101 assembly were utilized only 83.3% and 40% respectively. y After a keen analysis of the standard costs the sales manager concluded that Model 101 must be completely stopped from production, as the company was losing $1205 on each truck of Model 101 sold at $39000, whereas on the other hand Model 102 sold for $38000 was profitable. y The controller manager suggested that it would be better off to increase production of Model101 trucks, cutting back if necessary on Model 102 production.

y

The production manager suggested that Model 101 production could be increased without compromising on the production of Model 102 by purchasing engines for Model 101 or Model 102 from an outside supplier.

y

This could be possible by furnishing the necessary engine and machine components and reimburse the supplier for labour and overheads.

y

The main problem facing the company is that it wants a suitable product mix which can cater to their need of maximizing the profits and improve their financial position.

Problems

Q1. Find the best product mix for SUZ.

Solution: Using the Linear Programming model we can find the suitable product mix as follows:

**Step 1: Identifying Decision variables
**

X1 = Number of Model 101 trucks produced X2 = Number of Model 102 trucks produced

**Step 2: Formulate objective Function
**

Given data Selling Price of Model 101= $39,000 Selling Price of Model 102= $38,000 Direct material cost (Model101) = $24,000 Direct material cost (Model102) = $20,000 Direct labour cost (Model101) = $4,000 Direct labour cost (Model102) = $4,500 Variable Overhead cost (Per 1 Model101 truck) = $8000 Variable Overhead cost (Per 1 Model102 truck) = $8500 Fixed Overhead Cost (combined)= $8.6 million Utilizing the above given data we can formulate the objective function as follows Maximize Z= (39,000X1+ 38,000X2)-(24,000X1+20,000X2+4000X1+4500X2+8000X1+8,500X2+ 8.6million Therefore,on simplification

**Maximize Z= 3000x1+5000x2- 8.6 million
**

Step 3: Formulate constraints The constraints in the manufacturing of the two trucks is mainly seen in form of the capacity availability in each manufacturing division in form of net manufacturing hours available and hours required per truck. Keeping the pre requisite conditions intact the constraints for the problem are as follows: Subject to: i. ii. iii. iv. X1+ 2X2 4000 2X1+2X2 6000 2X1 5000 3X2 4500

Step 4: Non negativity Variables X1 , X2 0 Therefore the Linear programming problem for the case is as follows: Maximize Z= 3000x1+5000x2- 8.6 million Subject to: i. ii. iii. iv. X1+ 2X2 4000 2X1+2X2 6000 2X1 5000 3X2 4500

x1 and x2 0 *Solving by Simplex method following output is obtained:

*LPP solution output from TORA is also attached here with

**Cj -> 3000 0 0 5000 X1 S4 S3 X2
**

Zj -> ->

3000 X1 1 0 0 0 3000 0

5000 X2 0 0 0 1 5000 0

0 S1 -1 -3 2 1 2000 -2000

0 S2 1 1.5 -2 -0.5 500 -500

0 S3 0 0 1 0 0 0

0 S4 0 1 0 0 0 0

Bi 2000 1500 1000 1000

Thus the optimal mix given from the above optimal simplex table solution is X1= 2000 and X2= 1000 Thus substituting the objective function we have Z= 11, 00,000 ±$ 8.6 million = 24, 00,000

Thus with a product mix of 2000 model 101 trucks and 1000 model 102 trucks profit can be maximized to $ 24,00,000.

Q2. What would be the best product mix if engine assembly capacity were raised by one unit, from 4,000 to 4,001 machine-hours? What is the extra unit of capacity worth? Solution: In order to find the effect of the change in the hours in the engine assembly

on the solution we need to undertake the RHS ranging in order to ascertain that along what range of values for the engine assembly does the basis of the solution remains unchanged which can be ascertained as follows

Variables S1 -1 -3 2 1 S2 1 1.5 -2 -0.5 S3 0 0 1 0 S4 0 1 0 0 Bi 2000 1500 1000 1000

Ratio (BI/SJ) S1 -2000 -500 500 1000 S2 1000 -500 -2000 S3 1000 S4 1500

Therefore the ranges for the constraints are Constraint No 1 2 3 4 Present Value 4000 6000 5000 4500 Allowable Increase 500 500 Allowable decrease 500 1000 1000 1500 3500-4500 5000-6500 4000- 3000- Range

Now, as per the RHS ranging table the first constraint i.e engine assembly doesn¶t change over the range 3500-4500,thus if a single unit of engine assembly were added it would lead to a change in the optimal mix and no change in the basis, the new optimal mix can be found by solving the following constraint equations simultaneously:

X1+2X2= 4001 and 2X1 +2X2 = 6000 After solving the equations we have X1= 1999 and X2 = 1001 Z= 24, 02,000 Therefore, the optimal mix changes to 1999 model 101 trucks and 1001 model 102 trucks and profit has increased to $ 24,02,000 The worth of the extra unit of capacity would be equal to the shadow price associated with the engine assembly hours corresponding to the row value of S1 which is

2000,since the resource is scarce an additional unit of the resource would add 2000 to the profit,which can be see above wherein the new profit for the new mix has increased by over $2000 than the previous profit obtained from the original optimal mix. This each unit of capacity is worth $2,000

Q3. Assume that a second, additional unit of engine assembly capacity worth the same as the first. Verify that if the capacity were increased to 4,100 machine- hours, then the increase in contribution would be 100 times that in Q 2. Solution: As seen from the previous question, a unit increase in the engine assembly

capacity would lead to increase in profits by $2000.Therefore an increase in capacity of 100 units would lead to increase in profits by $2000*100,thus and increase of engine assembly capacity from 4000 to 4100 would lead to profit increasing 100 times.

Q4.How many units of engine assembly capacity can be added before there is a change in the value of an additional unit of capacity? Solution: As seen from Q2, the RHS range calculated for the engine assembly

ranges from 3500-4500 and the present value being 4,000 thus the maximum additional units up to which the value of the additional units remain unchanged is 4500-4000=500, thus up to a increase of 500 units from 4000 the value of an additional unit of capacity remains unchanged since the basis of the solution also remains unchanged.

Q5. SUZ¶s production manager suggests purchasing Model 101 or Model 102 engines from an outside supplier in order to relieve the capacity problem in the engine assembly department. If Merton decides to pursue this alternative, it will be effectively ³renting´ capacity: furnishing the necessary materials and engine components and reimbursing the outside supplier for labor and overhead. Should the company adopt this alternative? If so, what is the maximum rent it should be willing to pay for a machine-hour of engine assembly capacity? What is the maximum number of machine-hours it should rent? Solution: The company can go ahead for the option of getting the engine assembly

capacity on rent as it is a scarce resource for the company and a additional unit of capacity would still contribute to the profits, this can be seen as the calculations in Q2 above wherein as per the RHS ranging values the engine assembly capacity can still be increased by 500 units(Current =4000 ,maximum=4500) without changing the basis of the solution and also contribute $2000/rented hr to the profits( row value for S1), since

beyond the permissible range determined the basis would change along with change in the shadow price ,thus the company must only rent a maximum of 500 hours of engine assembly in order to contribute predictable additional profits of$2000/hr, this rented capacity must also not exceed the value(cost) of $2000 per hour rented as the incentive of renting additional capacity would be lost if the cost of rent is more than the contribution to the profit by the additional capacity.

y y

Maximum capacity to be rented- 500 hours Maximum value payable for additional capacity =$2,000

Q6.SUZ is considering the introduction of a new truck, to be called Model 103. Each Model 103 truck would give a contribution of $2,000. The total engine assembly capacity would be sufficient to produce 5,000 Model l03s per month, and the total metal stamping capacity would be sufficient to produce 4,000 Model lO3s. The new truck would be assembled the Model 101 assembly department, each Model 103 truck requiring only half as much time as a Model 101 truck. a) Should SUZ produce Model 103 trucks? b) How high would the contribution on each Model 103 truck have to be before it became worthwhile to produce the new model? Solution:

a. In order to introduce a new model of 103 truck into production the company would need to assess the cost of its production and utilization of resources as well as the contribution of the same towards augmentation of profits for the company. In case of Model 103 in engine assembly if exclusively produced the capacity would be sufficient for 5000 trucks, Thus Time for each Model 103 truck engine assembly= 4000/5000= 0.8 hrs Similarly Model 103 in Metal stamping if exclusively produced the capacity would be sufficient for 4000 trucks Thus Time for each Model 103 truck metal stamping=6000/4000 = 0.8 hrs Now as the capacity in metal stamping and engine assembly dept are scarce due to complete consumption by Model 101 and Model 102 production, thus additional capacity need to be purchased which must not exceed the value of the marginal profitability /shadow prices of $2000(engine assembly) and $500 (metal stamping).In the model 101 since there is additional left over capacity thus it can be utilized for producing Model 103 truck and need not be purchased and thus shadow price would be zero.

Now, assessing the cost of producing Model 103 we get Engine Assembly= 0.8*$2000 = $1600 Metal stamping= 1.5*$500 = $750 Model 103 assembly= 1 * 0 = 0 Total cost incurred = $ 2350 Contribution per Model 103 truck= $ 2000 Therefore, since each Model 103 would give a contribution of $ 2000 to the profits but also incur $2350 as cost in order to produce it, the company should not produce Model 103 trucks as this would be a loss making decision. b) In order to introduce the Model 103 truck into the production and also be profit making or no loss the contribution per truck must increase by at least $350 from current contribution of $2000

Q7. Engines can be assembled on overtime in the engine assembly department. Suppose production efficiencies do not change and 2,000 machine-hours of engine assembly overtime capacity are available. Direct labor costs are higher by 50% for overtime production. While variable overhead would remain the same, monthly fixed overhead in the engine assembly department would increase by $0.75 million. Should SUZ assemble engines on overtime? Solution:

Since the company wants to produce additional trucks in overtime thus the amount of trucks produced in overtime must be allotted different decision variables as follows: X3= Number of Model 101 trucks produced in overtime X4= Number of Model 102 trucks produced in overtime Now We need to include the contribution of these overtime produced trucks to the objective function also, since the labour cost is higher by 50% in overtime thus the intial contributions by Model 101(3000X1) and Model 102 (5000X2) would reduce in overtime by the amount of increase in respective labour costs. Thus Model 101 overtime object function component= 3000X1 - 600 X1= 2400 X3 Model 102 overtime object function component= 5000X2 -1200 X2 = 3800X4 Therefore the modified objective function is as follows

Z= 3000X1+5000X2+ 2400 X3 +3800X4 ±$ 8.6 million-$ 0.75

million

Z= 3000X1+5000X2+ 2400 X3 +3800X4±$ 9.35 million Subject to: i. ii. iii. iv. v. X1+ 2X2 4000 2X1+2X2 6000 2X1 5000 3X2 4500 X3+ 2X4 2000 (additional capacity for overtime in engine assembly) Non negativity X1 ,X2 ,X3 ,X4 > 0

*Solving the following by simplex method we get Optimal mix as Model 101= 2000 trucks Model 102= 1000 trucks Model 101(Overtime) = 2000 trucks Model 102(Overtime) = 0 trucks The value of the objective function is as follows Z= 3000(2000) +5000(1000)+2400(2000)+3800(0)- 9.35 million Z= 1, 58, 00,000-93,50,000= $64, 50,000 Since by conducting overtime production for Model 101 the company gets more profits than the profits for initial optimal mix calculated in Q1 i.e. 24,00, 000. (64, 50,000-24, 00,000=$40, 50,000) the company should go ahead with the proposed overtime proposal in order to maximize profits *LPP solution output from TORA is also attached here with

Q8.

SUZ¶s

president,

in

arguing

that

maximizing

short-run

contribution was not necessarily good for the company in the long run, wanted to produce as many Models 101 is as possible. After some discussion it was agreed to maximize the monthly contribution as long as the number of model 101 trucks produced was at least three times the no of model 102. What is the optimal mix in this case? Solution The company proposes to add an additional constraint to the production by stating that it was mandatory to have Model 101 trucks produced at least 3 times that of Model 102 trucks. Thus from the intial LPP formulation we have Z= 3000X1+5000X2±$ 8.6 million Subject to: i. ii. iii. iv. X1+ 2X2 4000 2X1+2X2 6000 2X1 5000 3X2 4500

To this an additional constraint must be added as follows: Z= 3000X1+5000X2±$ 8.6 million Subject to: i. ii. iii. iv. v. X1+ 2X2 4000 2X1+2X2 6000 2X1 5000 3X2 4500 X1 3X2 (OR) X1- 3X2 0

*Solving the problem through simplex method We get the following optimal mix X1= 2250 X2= 750 and the value of the objective function as Z= 3000(2250)+5000(750)-8.6 million Z= 10500000-86, 00,000=19, 00,000 Thus in this case wherein the organization wants to produce Model 101 trucks at least 3 times the quantity of Model102 ,the optimal mix in the case is 2250(Model 101 trucks) and 750(Model 102 trucks) with a profit of $19,00,000.

*LPP solution output from TORA is also attached here with

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