LINEAR PROGRAMMING CASE

SUBMITTED TO :- Prof. KC.MAHESH SUBMITTED BY :[AJAY] [SHILPI] [NURUBI] [PANKTI] [ISHITA] [MITUL]

Agenda
Investment strategy Case Managerial implications Hart venture capital Case Managerial implications

CASE 1

Investment strategy
J.D. Williams is an investment advisory firm that manages more than $120 million in funds for its numerous clients. The company uses an asset allocation model that recommends the portion of each clients portfolio to be invested in a growth stock fund, an income fund & a money market fund. The amount invested in the fund must be between 20% & 40% of the total portfolio value. similarly for other funds between 20% & 50% of total portfolio value must be in the income fund & at least 30% of total portfolio value must be in money market fund. Eg: William just contracted with a new client who has $800000 to invest. William assigned a maximum risk index of 0.05 for the client. Firms first indicator show the risk of the growth fund at 0.10. he income fund at 0.07 & money market fund at 0.01. Additionally Williams is currently forecasting annual yields of18% for growth fund, 12.5% of income fund & 7.5% of money market fund. Based on the information provided, how should the new client be advised to allocate the $800000 among the growth, income & money market funds?

L.P Model Formulation

Decision variables: Growth fund(GF),Income fund (IF),Money
Market fund(MMF)

Maximum risk index: 0.05 Objective function: To maximize the total yield for the portfolio. Max Z = 0.18 GF + 0.125 IF + 0.075 MMF Subject to constraint:
1GF+1IF+1MMF <= 800,000 0.80GF - 0.20IF - 0.20MMF >= 0 0.60GF - 0.40IF - 0.40MMF <= 0 - 0.20GF+0.80IF - 0.20MMF >= 0 - 0.50GF+0.50IF - 0.50MMF <= 0 - 0.30GF - 0.30IF+0.70MMF >= 0 0.05GF+0.021F - 0.04MMF <= 0

The present table provides information which outlines the key assumptions take into consideration in the development of the investment recommendation.
Portfolio Risk Indicators 0.10 0.07 0.01

Excel output:

Growth Stock Fund Income Fund Money Market Fund

Forecasted Annual Yields 0.18 0.125 0.075

Recommend how much of the $8000000 should be invested in each of the three funds. What is the annual yield you anticipate for investment recommendation?
Growth Fund Income Fund Money Market Fund Total = $2,47,111 = $1,60,000 = $3,92,889 = $800,000

The anticipated annual yield is : Growth Fund = $2,47,111 x 0.18 Income Fund = $160,000 x 0.125 Money Market Fund = $3,92,889 x 0.075 Total Total Anticipated Annual Yield = $93,947/ $800,000 = 11.74%

= $44,480 = $20,000 = $29,467 = $93,947

Assume that the client risk index could be increased to 0.055. how much would the yield increase and how much would the investment recommendation change?
Growth Fund Income Fund Money Market Fund Total = $2,93,333 = $1,60,000 = $3,46,667 = $800,000

The anticipated annual yield is : Growth Fund = $2,93,333 x 0.18 Income Fund = $160,000 x 0.125 Money Market Fund = $3,46,667 x 0.075 Total Total Anticipated Annual Yield = $98,800/ $800,000 = 12.35%

= $52,800 = $20,000 = $26,000 = $98800

Refer again to the original situation where the client s risk index was assessed to be 0.055. how would your investment recommendation change if the annual yield for the growth fund were revised downward to 16% or even to 14%?
Growth Fund Income Fund Money Market Fund Growth Fund Income Fund Money Market Fund = $2,47,111 x 0.16 = $160,000 x 0.125 = $3,92,889 x 0.075 Total = $2,47,111 x 0.14 = $160,000 x 0.125 = $3,92,889 x 0.075 Total = $39,537 = $20,000 = $29,467 = $89,004 = $34,595 = $20,000 = $29,467 = $84,062

Original Total Anticipated Annual Yield = $98,800 So at 16% there is decrease in annual yield of 9,796 at 14% there is decrease in annual yield of 14,738

Assume that client expressed some concern about too much money in the growth fund. How would original recommendation change if the amount invested in the growth fund is not allowed to exceed the amount invested in the income fund?
Given the risk of 0.10 and 0.07 of the growth fund and income fund respectively, the client may opt to choose a less aggressive approach by limiting the growth funds investment amount to equal, yet not surpass, the amount invested in the income fund. This change in investment strategy, however, would generate a lower annual yield of $85,067, than the projected annual return of $94,133 by the original, more risky recommendation. Because annual yield of growth fund is 18% & of income fund is 12.5% . so growth fund will give higher return as compared to income fund but it has higher risk .10. so for more annual yield more amount should be invested in the Growth fund.

The asset allocation model you developed may be useful in modifying portfolios for all of the firm s clients whenever the anticipated yields for the three funds are periodically revised. What is your recommendation as to whether use of this model is possible?
J.D William would recommend the use of this model only when the potential new clients meet the present outline criteria i.e., similar objectives and constraints. The company mission, however, is to provide the professional, financial advised that best meets the individual investors needs. The company would therefore, not recommend the use of this asset allocation model as a general guide to financial investment.

CASE 2

Hart venture capital

Hart venture capital specializes in providing venture capital for software development which has two investment opportunities i.e., security system & market analysis. In exchange of security system & market analysis firm has asked HVC to provide $6000000 in a year,$6000000 in 2 year & 2500000 in 3 year the coming three year period. For market analysis $500000 in a year,$350000 in 2 year & $400000 in 3 year over the same three year period. They are willing to commit at most $800000 for both projects in first year, $700000 in 2 year & $500000 in 3 year. Using an 8% rate of return, security system has a net present value of $1800000 & market analysis have $1600000 eg: if HVC decides to fund 40% of security system project, investment of 0.40($600000)=$240000 require in a year, 0.40($600000)=$2400000 in 2 year & 0.40($250000)=$100000in 3 year, the net present value of security system would be 0.40($1800000) = $720000

Identification of the problem

Hart Venture Capital has two Investment opportunities:Security Systems. Market Analysis. HVC want to maximize their Net Present Value by investing in these two projects. The year wise requirement of funds for these two projects are given below:At the 8% Rate of Return, The Net Present Value for Security System is 1,800,000. The Net Present Value for Market Analysis is 1,600,000. The Total Budget limitations of HVC for three years are 800,000, 700,000 & 500,000 respectively. Let S=% of total amount invested in System Securities. M=% of total amount invested in Market Analysis.
Project Name Security System Market Analysis 1st Year 6 5 2nd Year 6 3.5 3rd Year 2.5 4

*[Note:-All the figures are in Lac (00,000 $)]

Objective function Max Z = 1,800,000 (S) + 1,600,000 (M) Subject to constraint 600,000 (S) + 500,000 (M) 800,000 600,000 (S) + 350,000 (M) 700,000 250,000 (S) + 400,000 (M) 500,000 S >= 0 M >= 0

e e e u u

c1 c2 c3 obj fun Values Max

x1 6 6 2.5 18 0.608696 24.86957

x2 5 3.5 4 16 0.869565

Utilized 8 6.6956522 5

operator

<= <= <=

RHS 8 7 5

Graphical Solution

There are three extreme points (A, B, C, D) and the optimal point at point C. The reason is that C is the farthest point from the origin. Point C is on the intersection of Constrain 1 and 3.

Extreme Points and Optimal Point Therefore: 600,000 (S) + 500,000 (M) = 800,000 => 6S + 5M =8 250,000 (S) + 400,000 (M) = 500,000 => 2.5S + 4M =5 S=60.86956% M=86.95652% At the optimal point (point c), HVC should fund 61% of the Security Systems project and 87% of the Market Analysis. The total net present value will be: $ 2,486,956.52 Point A Refer to the graph S=133% M =0 Point A 133% S and 0% M will fund. The total net present value will be: $ 2,394,000.00 Point B 600,000 (S) + 500,000 (M) = 800,000=> 6S+5M=8 600,000 (S) + 350,000 (M) = 700,000=> 6S+3.5M=7 M= 66.66666% S= 77.77777%

Point B 600,000 (S) + 500,000 (M) = 800,000=> 6S+5M=8 600,000 (S) + 350,000 (M) = 700,000=> 6S+3.5M=7 M= 66.66666% S= 77.77777% At the Point B, 67% S and 77% M will fund. The total net present value will be: $ 2,466666.67 Point D Refer to the graph S= 0% M = 125% At the Point B, 69% S and 82% M will fund. The total net present value will be: $ 2,000,000.00

Slack and Surplus

Total Investment in Year 1 Total Investment in Year 2 Total Investment in Year 3 S*600,0 00 S*600,0 00 S*250,0 00 M*500,000 M*350,000 M*400,000 = = = 800,000 700,000 500,000

To find the slack determine the percentage funded and subtract that from the total allowable investment that HVC is willing to commit.
Slack S=61% M=87 % Total investment in Year 1 Total investment in Year 2 Total investment in Year 3 S*600,000 S*600,000 S*250,000 M*500,000 M*350,000 M*400,000 = = = A 6,69,56 5 5,00,00 0 . . . $800,00 0 $700,00 0 $500,00 0 $. $ 30,435 $.

The result is that there are slacks in the non-binding constrains. There is still $ 30,435.00 that could invest in the second year.

Range of Optimality The range of optimality is how much the optimal solution variable can change until the extreme point is changed. To calculate this set the slope of the optimal solution between the two binding solutions.

S -1.6 - S/M -5/6 = -1.6 -S/1,600,000 -5/6 1.6 S/1,600,000 5/6 1,333,333.33 S 2,560,000 M -1.6 - S/M -5/6 = -1.6 - 1,800,000/M -5/6 5/6 1,800,000/M 1.6 1,125,000 M 2,160,000

What is the recommendation percentage of each project that HVC should fund and the net present value of the total investment.
The recommended numbers for HVC should fund : 61% of Security Systems stock 87% of Market Analysis. The net present value of total investment is $ 2,486,956.52

What capital allocation plan for security systems & market analysis for the coming three year period and the total HVC investment each year would you recommend?

Security System Stock Investment in Year 1 Investment in Year 2 Investment in Year 3 $ $ $ 365,217.39 365,217.39 152,173.91

Market Analysis $ 434,782.61 $ 304,347.83 $ 347,826.09 $ $ $

total 800,000.00 669,565.22 500,000.00

What effect, if any, would HVC s willingness to commit an additional $1000000 during the first year have on the recommended percentage of each project that HVC should fund?
If HVC is willing to commit an additional $100,000 during the first year, the recommend percentage of the Security System Stock will increase to 69% and the number of Market Analysis will decrease to 82%; the net present value will change to $2,550,82 In this case, the bindings will change from constraint 1 and 3 to constraint 2 and 3.

S=69%

M=82%

MaxZ=2,55,082

UTILIZED OPERATOR ($) Total Investment in Year 1 Total Investment in Year 2 Total Investment in Year 3 = S*600,000 M*500,000 = S*600,000 M*350,000 = S*250,000 M*400,000 5,00,000 7,00,000 <= 8,22,950 <= <=

RHS ($)

SLACK ($)

9,00,00 77,049. 0 18 7,00,00 0 5,00,00 0 0

What would the capital allocation plan look like if an additional $1000000 is made available.?
Adding all $100,000 to constraint 1 S=69% M=82% MaxZ=2,55,082

UTILIZED ($) Total Investment in Year 1 Total Investment in Year 2 Total Investment in Year 3 = S*600,000 S*600,000 S*250,000 M*500,000 M*350,000 M*400,000 = = 8,22,950 7,00,000 5,00,000

OPERATOR

RHS ($) 9,00,000

SLACK ($) 77,049.1 8 0 0

<=

<= <=

7,00,000 5,00,000

What is your recommendation as to whether HVC should commit the additional $1000000 in the first year? $22,950.8197 out of the additional $100,000 should be allocated to the first year.
Capital allowed to Security Systems in 1st year = 600,000*0.35=$210,000 Capital allowed to Markey Analysis in 1st year = 500,000*1.22=$610,000

THANK-YOU