Chapter 14

Applications of
Linear Optimization

Lecturer: Nguyen Van Dung Ph.D.

Slides are based on slides accompanied the book “Business Analytics:
Methods, Models, and Decisions”, with improvement from the lecturer
Applications of Linear Optimization
Building Linear Optimization Models
 Building optimization models is more of an art
than a science.
◦ Learning how to build models requires logical thought
facilitated by studying examples and observing their
characteristics.
 Key issues:
◦ Formulation
◦ Spreadsheet implementation
◦ Interpreting results
◦ Scenario and sensitivity analysis
◦ Gaining insight for making good decisions
Types of Constraints in Optimization
Models
 Simple Bounds (giới hạn)
◦ Constraints on values of a single variable
 Limitations
◦ Allocation of scarce resources
 Requirements
◦ Minimum levels of performance
 Proportional (tỷ lệ) Relationships
◦ Requirements for mixtures or blends (pha trộn) of materials or
strategies
 Balance Constraints
◦ Ensure the flow of material or money is accounted for at
locations or between time periods: input = output
Process Selection Models
 Process selection models generally involve
choosing among different types of processes to
produce a good.
◦ Example: make or buy decisions
Example 14.1: Camm Textiles
 A mill that operates on a 24/7 basis produces three types
of fabric (vải) on a make-to-order basis.
 The key decision is which type of loom (khung cửi dệt
vải) to use for each fabric (vải) type over the next 13
weeks.
 The mill has 3 dobbie looms and 15 regular looms.
 If demand cannot be met, the fabric is outsourced.
Example 14.1 Continued
 Model Formulation
 Di = yards fabric i to produce on dobbie loom
 Ri = yards fabric i to produce on regular loom
 Pi = yards fabric i to outsource
 Objective
 Minimize total cost of milling (sự xay, sự nghiền, sự cán)
and outsourcing
 Constraints
 Requirements: Total production and outsourcing of each
fabric = demand
 Limitations: Production on each type of loom cannot
exceed the available production time
 Nonnegativity
Example 14.1 Continued
 Demand constraints
 Production + outsourcing = demand

◦ Fabric 1: D1 + P1 = 45,000
◦ Fabric 2: D2 + R2 + P2 = 76,500
◦ Fabric 3: D3 + R3 + P3 = 10,000
Example 14.1: Continued
 Loom capacity limitation constraints
 First convert yards/hour into hours/yard.
E.g., for fabric 1 on the dobbie loom:
hours/yard = 1/(4.7 yards/hour) = 0.213 hours/yard

 Capacity of the three dobbie looms:

(24 hours/day)(7 days/week)(13 weeks)(3 looms) = 6,552 hours
 Constraint on available production time on dobbie looms:
0.213D1 + 0.192D2 0.227D3 ≤ 6,552
 Constraint for regular looms:
0.192R2 + 0.227R3 ≤ 32,760
Example 14.1 Continued
 Full Model
Spreadsheet Design
 Camm Textiles model

 Decision variables
 Objective
 Solver Model

Set cell C14 to zero as a constraint because

fabric 1 cannot be produced on a regular loom.
Whenever you restrict a single decision variable
to equal a value or set it as a ≤ or ≥ type of
constraint, Solver considers it as a simple bound.
Example 14.2: Interpreting Solver
Reports for the Camm Textiles Problem
 Answer Report
Example 14.2: Interpreting Solver
Reports for the Camm Textiles Problem
 Sensitivity Report
Solver Output and Data Visualization
 Solver requires some technical knowledge of
linear optimization concepts and terminology, such
as reduced costs and shadow prices (giá mờ-see
note).
 Data visualization can help analysts present

optimization results in forms that are more

understandable and can be easily explained to
managers and clients in a report or presentation.
Answer Report Visualization
 Camm Textiles
Sensitivity Report Visualization
 Reduced costs: how much the unit production or
purchasing cost must be changed to force the value of a
variable to become positive in the solution.
Visualizing Allowable Ranges
 Unit cost coefficients: use an Excel Stock Chart (see text
for details).
◦ A stock chart typically shows the “high-low-close” values of daily
stock prices; here we can compute the maximum-minimum-
current values of the unit cost coefficients.

For those lines that have

no maximum limit (the blue
dash) such as with Fabric 1
Purchased, the unit costs
can increase to infinity; for
those that have no lower
limit (the red triangle) such
as Fabric 1 on Dobbie, the
unit costs can decrease
indefinitely.
Visualizing Shadow Prices
 Shadow prices show the impact of changing the right-hand side of a
binding constraint. Because the plant operates on a 24/7 schedule,
changes in loom capacity would require in “chunks” (i.e., purchasing
an additional loom) rather than incrementally (gia tăng, tăng thêm).
 However, changes in the demand can easily be assessed using the
shadow price information.
Visualizing Allowable Ranges for
Shadow Prices
 Stock Chart
Blending Models
 Blending problems involve mixing several raw
materials that have different characteristics to
make a product that meets certain specifications.
◦ Dietary planning, gasoline and oil refining, coal and
fertilizer production, and the production of many other
types of bulk commodities involve blending.
 We typically see proportional constraints in
blending models.
Example 14.3: BG Seed Company
 BG Seed Company is developing a new birdseed
(hạt dùng cho chim ăn) mix.
◦ Nutritional requirements specify that the mixture contain
at least 13% protein, at least 15% fat, and no more than
14% fiber.
◦ BG’s objective is to determine the minimum cost mixture
that meets nutritional requirements.
Example 14.3 Continued
 Formulating the model
 Define Xi = pounds of ingredient i in 1 pound of mix
 Objective function
 minimize 0.22X1 + 0.19X2 + 0.10X3 + 0.10X4 + 0.07X5 +
0.05X6 + 0.26X7 + 0.05X6 + 0.26X7 + 0.11X8
Example 14.3 Continued
 Protein constraint
 Total pounds of protein provided/total pounds of mix ≥
0.13
◦ (0.169X1 + 0.12X2 + 0.085X3 + 0.154X4 + 0.085X5 + 0.12X6 +
0.18X7 + 0.119X8)/(X1 + X2 + X3 + X4 + X5 + X6 + X7 + X8) ≥ 0.13
 Add constraint X1 + X2 + X3 + X4 + X5 + X6 + X7 + X8 = 1
◦ Protein constraint simplifies to
◦ 0.169X1 + 0.12X2 + 0.085X3 + 0.154X4 + 0.085X5 + 0.12X6 +
0.18X7 + 0.119X8 ≥ 0.13

Formulate other nutritional

constraints in a similar way.
Example 14.3 Continued
 Complete model
Spreadsheet Implementation of BG Seed
Company
Solver Model for BG Seed Company
Dealing with Infeasibility
 Solver solution shows the model is infeasible!
 Solver Feasibility Report

A conflict exists in trying to meet both fat and fiber constraints.

Only sunflower seeds and safflower contain enough fat but they
also have a lot of fiber.
What-If Scenarios
 Lower the fat requirement or raise the fiber
limitation

1st Scenario:
Fat requirement is lowered from
15% to 14.5%.
2nd Scenario:
Fiber limitation is raised from
14% to 14.5%.

Optimal Cost per pound:

$0.148 if fat requirement lowered
$0.152 if fiber limitation raised
Portfolio Investment Models
 Many types of financial investment problems are
modeled and solved using linear optimization.
 Such portfolio investment models problems have

the basic characteristics of blending models.

Example 14.4: Innis Investments
 Innis Investments manages 6 mutual funds. A client
wants to invest a $500,000 inheritance. The objective is
to minimize risk.
 Constraints:
 Invest no more than $200,000 in any one fund.
 Invest at least $50,000 each in the multinational and balanced
funds.
 Invest at least 40% combined in the income equity and balanced
funds.
 Achieve an average return of at least 5%.
Example 14.4 Continued
 Model Formulation
 Define Xi = dollar amount invested in fund i
◦ The total risk would be measured by the weighted risk of the
portfolio, where the weights are the proportion of the total
investment in any fund (Xj/500,000)
Example 14.4 Continued
 Constraints
◦ Invest all money:

◦ Achieve required return:

◦ Have at least 40% in income equity and balanced funds:

◦ At least $50,000 in each of multinational and balanced funds:

◦ Restrict each investment to $200,000, and include nonnegativity:

Spreadsheet Implementation for Innis
Investments
Solver Model for Innis Investments
Example 14.5: Risk versus Reward
 Innis Investments
◦ Allowable Increase and Allowable Decrease values for the
weighted return are very small, 0.00906 and 0.00111,
respectively; so any changes in the target return will require re-
solving the model.
Scaling Issues in Using Solver
 A poorly scaled model is one that computes values of
the objective, constraints, or intermediate results that
differ by several orders of magnitude.
 Poor scaling can cause Solver engines to return
messages such as “Solver could not find a feasible
solution,” “Solver could not improve the current solution,”
or even “The linearity conditions required by this Solver
engine are not satisfied,” or it may return results that are
suboptimal.
◦ In the Solver options, you can check the box Use Automatic
Scaling.
◦ The best way to avoid scaling problems is to carefully choose the
“units” implicitly used in your model so that all computed results
are within a few orders of magnitude of each other.
Example 14.6: Little Investment
Advisors
 Little Investment Advisors is working with a client on
determining an optimal portfolio of bond funds. The client
has $350,000 to invest and wants to achieve the largest
weighted percentage return and keep the weighted risk
measure no greater than 5.00.
Example 14.6 Continued
 Model
◦ Define X1 through X6 be the amount invested in each of the six
funds.
◦ Maximize (6.11X1 + 7.61X2 + 5.29X3 + 2.79X4 + 7.37X5 +
5.65X6)/350,000
◦ X1 + X2 + X3 + X4 + X5 + X6 = 350,000
◦ (4.62X1 + 7.22X2 + 9.75X3 + 3.95X4 + 6.04X5 + 5.17X6) ≤ 5.00
◦ X1,…,X6 ≥ 0
Example 14.6 Continued
 Premium Solver solution without scaling, resulting in an
incorrect solution!
Example 14.6 Continued
 Solver solution after scaling the variables
Transportation Models
 The transportation problem involves determining
how much to ship from a set of sources of supply
(factories, warehouses, etc.) to a set of demand
locations (warehouses, customers, etc.) at
minimum cost.
Example 14.7: General Appliance
Corporation
 GAC produces refrigerants at 2 plants and ships to 5
distribution centers.

 Define the decision variables as: Xij = amount shipped

from plant i to distribution center j
 The objective is to minimize the total cost of shipping
between plants and distribution centers.
◦ minimize 12.60X11 + 14.35X12 + 11.52X13 + 17.58X14 + 9.75X21 + 16.26X22
+ 8.11X23 + 17.92X24
Example 14.7 Continued
 Constraints
◦ The amount shipped from each plant cannot exceed its
capacity.
◦ Demand at each distribution center is met.
◦ Nonnegativity
GAC Spreadsheet Implementation and
Solver Model
Formatting the Sensitivity Report
 Depending on how cells in your spreadsheet model are
formatted, the Sensitivity report produced by Solver may
not reflect the accurate values of reduced costs or
shadow prices because an insufficient number of
decimal places may be displayed.
 We highly recommend that after you save the Sensitivity
report to your workbook, you select the reduced cost and
shadow price ranges and format them to have at least
two or three decimal places.
Example: GAC Sensitivity Report

Original Sensitivity Report Reformatted Sensitivity Report

Example 14.8: Interpreting Sensitivity
Information for the GAC Model
 Reduced costs tell how
much the unit shipping
cost would have to be
reduced to make it
attractive to ship along a
route.
 We cannot increase the
demand at any
distribution center
without creating an
infeasible problem. The
shadow prices reflect the
cost savings that would
occur for a unit decrease
in demand at one of the
distribution centers.
Degeneracy
 The GAC solution exhibits a phenomenon called
degeneracy (sự thoái hoá). A solution is degenerate if
the right-hand-side value of any constraint has a zero
Allowable Increase or Allowable Decrease.
◦ Degeneracy can impact the interpretation of sensitivity analysis
information. For example, reduced costs and shadow prices may
not be unique, and you may have to change objective function
coefficients beyond their allowable increases or decreases before
the optimal solution will change.
Multiperiod Production Planning
Models
 The basic decisions are how much to produce in each
time period to meet anticipated demand over each
period.
 Although it might seem obvious to simply produce to the
anticipated level of sales, it may be advantageous to
produce more than needed in earlier time periods when
production costs may be lower and store the excess
production as inventory for use in later time periods,
thereby letting lower production costs offset the costs of
holding the inventory.
Example 14.9: K&L Designs
 K&L Designs makes hand-painted jewelry boxes.
 Forecasted sales are 150 in autumn, 400 in winter, and 50 in
spring.
 Unpainted boxes cost $20 and each box takes 2 hours to
complete.
 The cost of capital is 6% per quarter.
 Holding cost per item = 0.06(20) = $1.20/quarter
 Labor rates are $5.50, $7.00, and $6.25 per hour during autumn,
winter, and spring, respectively.
 Minimize the combined cost of production and inventory
holding costs.
Example 14.9 Continued
 Decision variables
◦ Pi = amount to produce in quarter i (1 = autumn; 2 =
winter; 3 = spring)
◦ Ii = inventory at the end of quarter i
Example 14.9 Continued
 Objective function
◦ The production cost per unit is computed by multiplying the labor
rate by the number of hours required to produce one.
◦ Thus, the unit cost in the autumn is ($5.50)(2) = $11.00; in the
winter, ($7.00)(2) = $14.00; and in the spring, ($6.25)(2) = $12.50.
Example 14.9 Continued
 Constraints
◦ Satisfy demand using production in a quarter and the inventory
held from the previous time quarter. Any amount in excess of the
demand is held to the next quarter.
◦ Therefore, the constraints take the form of inventory balance
equations:
Example 14.9 Continued
 Complete model
Spreadsheet Implementation for K&L
Designs
Solver Model for K&L Designs
Example 14.10: An Alternative
Optimization Model for K&L Designs
 To ensure that demand is satisfied, we can set the
cumulative production in each quarter to be at least as
great as the cumulative demand.
◦ This eliminates inventory variables.
Alternative Spreadsheet Model
Alternative Solver Model
Comparison of Sensitivity Reports
Example 14.11: D.A. Branch & Sons
 The company’s financial manager needs to ensure that
funds are available to pay expenses yet needs to
maximize investment income.
 Three short-term investments are being considered:
 1-month CD paying 0.25%
 3-month CD paying 1.00% at maturity
 6-month CD paying 2.30% at maturity
 The net expenditures for the next 6 months are forecast
as $50,000, ($12,000), $23,000, ($20,000), $41,000, and
($13,000)
 A cash balance of $10,000 must be maintained.
Currently the cash balance is $200,000.
Example 14.11 Continued
 Model development
◦ Ai = amount ($) to invest in a 1-month CD at the start of month i
◦ Bi = amount ($) to invest in a 3-month CD at the start of month i
◦ Ci = amount ($) to invest in a 6-month CD at the start of month i
Example 14.11 Continued
 Optimization model
Spreadsheet Model for D.A. Branch &
Sons
Spreadsheet Model Formulas for D.A.
Branch & Sons
Solver Model for D.A. Branch & Sons
Models with Bounded Variables
 Solver handles simple lower bounds (e.g., C ≥ 500) and
upper bounds (e.g., D ≤ 1,000) quite differently from
ordinary constraints in the Sensitivity report.
 Lower and upper bounds are treated in a manner similar
to nonnegativity constraints, which also do not appear
explicitly as constraints in the model.
 This makes it more difficult to interpret the sensitivity
information, because we no longer have the shadow
prices and allowable increases and decreases
associated with these constraints.
Example 14.12: J&M Manufacturing
 J&M Manufacturing makes 4 models of gas grills
 Determine how many grills to produce in order to
maximize profit.
Example 14.12 Continued
 Model development
◦ Define A, B, C, and D number of units of models A, B, C, and D
to produce, respectively.
◦ The objective function is to maximize the total net profit:
maximize (250 - 210)A + (300 - 240)B + (400 - 300)C + (650 -
520)D = 40A + 60B + 100C + 130D
 Constraints include limitations on the amount of
production hours available in each department, the
minimum sales requirements, and maximum sales
potential limits.
◦ Watch the dimensions carefully!
Example 14.12 Continued
 Constraints:
◦ Department capacity

◦ Minimum sales requirements and maximum sales

potential
Spreadsheet Implementation for J&M
Manufacturing
Spreadsheet Model Formulas for J&M
Manufacturing
Solver Model for J&M Manufacturing
J&M Manufacturing Answer Report
J&M Manufacturing Sensitivity Report

Note that none of the bound constraints appear in the

Constraints section.
Interpreting Reduced Costs
 For product B, the lower bound constraint is B ≥ 0. How much more
would the profit on B have to be in order for it to be economical to
produce anything other than the minimum amount required?
◦ The answer is given by the reduced cost. The unit profit on B would have to be
reduced by at least - $1.905 (that is, increased by at least + $1.905).
 Product D is at its upper bound.
◦ The reduced costs of $19.29 tells how much the unit profit have to be lowered
before it is no longer economical to produce the maximum amount
Interpreting Reduced Costs as
Shadow Prices
 Increasing the right-hand-side value of the bound constraint, B ≥ 0,
by 1 unit will result in a profit reduction of $1.905.
 Increasing the right-hand side of the constraint D ≤ 1,000 by 1 will
increase the profit by $19.29.
◦ The reduced cost associated with a bounded variable is the same as the shadow
price of the bound constraint. However, we no longer have the allowable range
over which we can change the constraint values.
Auxiliary Variables for Bound Constraints
 Auxiliary variables are a new set of cells for any
decision variables that have upper- or lower-bound
constraints created by referencing (not copying) the
original changing cells.
 In the Solver model, use auxiliary variable cells—not the
changing variable cells as defined—to define the bound
constraints.
 Auxiliary variables allow easier interpretation of shadow prices for
bounded variables.
Example 14.13: Using Auxiliary Variable
Cells
 J&M Manufacturing model

Define bound constraints using

the auxiliary variable cells
Example 14.13 Continued
 Sensitivity
report
 Bound
constraints not
appear in the
Constraints
section
Example 14.14: Walker Wines
 A production/marketing allocation problem
 Walker Wines buys grapes from local growers and blends the
pressings to make two types of wine (Shiraz and Merlot). Grape
costs are $1.60 per bottle Shiraz and $1.40 per bottle Merlot.
 Their contract requires between 40% and 70% of their wine to be
Shiraz.
 Predicted demand for Shiraz is 1000 bottles but increases by 5
bottles for each dollar spent on advertising; the base demand for
merlot is 2,000 bottles and increases by 8 bottles for each $1 spent
on advertising.
 Production should not exceed demand.
 Shiraz sells to retail stores for $6.25 per bottle and merlot is sold for
$5.25 per bottle.
 $50,000 is available to purchase grapes and advertise products.
Example 14.14 Continued
 Model formulation
 Define
◦ S = number of bottles of Shiraz produced
◦ M = number of bottles of merlot produced
◦ As = dollar amount spent on advertising Shiraz
◦ Am = dollar amount spent on advertising merlot
 Maximize profit = ($6.25S + $5.25M) - ($1.60S + $1.40M
+ As + Am) = 4.65S + 3.85M - As - Am
Example 14.14 Continued
 Constraints
 Do not exceed budget

◦ $1.60S + $1.40M + As + Am ≤ $50,000

 Meet contractual requirements
◦ 0.4 ≤ S/(S + M) ≤ 0.7, or expressed in linear form:
0.6S - 0.4M ≥ 0 and 0.3S - 0.7M ≤ 0
 Production must not exceed demand
◦ S ≤ 1,000 + 5As
◦ M ≤ 2,000 + 8Am
 Nonnegativity
Spreadsheet Implementation for
Walker Wines
Solver Model for Walker Wines
Using Sensitivity Information
Correctly
 One crucial assumption in interpreting sensitivity
analysis information for changes in model
parameters is that all other model parameters are
held constant.
Example 14.15: Evaluating a Cost
Increase for Walker Wines
 Suppose the cost of Shiraz grapes increase $0.05 per bottle.
 A $0.05 increase in cost results in a drop in the unit profit of Shiraz
from $4.65 to $4.60. In the Sensitivity report, however, the change
in the profit coefficient is within the allowable decrease of 0.05328,
thus concluding that no change in the optimal solution will result.
Example 14.15 Continued
 If the model is re-solved
using the new cost
parameter, the solution
changes dramatically.
 In this case, the unit cost
is also reflected in the
binding budget constraint.
When we change the cost
parameter, the constraint
also changes. This
violates the assumption
that all other model
parameters are held
constant.