Linear Programming Applications in Finance

1. A company must produce two products over a period of 3 months. The company can pay for materials and labor from two sources: company funds and borrowed funds. The firm has to take three decisions. a. How many units of product 1 should it produce b. How many units of product 2 should it produce c. How much money it should borrow to support the production of the products. The firm must take these decisions in order to maximize the profit contribution subject to the conditions given below. i. Since the companys products enjoy a sellers market the company can sell as many units as it can produce. The company would therefore like to produce as many units as possible, subject to its production capacity and financial constraints. The capacity constraints, together with price data are shown in the following table.
Product Selling price (Rs. Per unit) Cost of Production (Rs. Per unit) Required hours per unit in department

1 14 10 2 11 8 Available hours per production period of three months

A 0.5 0.3 500

B 0.3 0.4 400

C 0.2 0.1 200

ii The available company funds during the production period will be Rs. 3 lakhs iii A bank will give loans up to Rs. 2 lakh per production period at an interest rate of 20% per anum provided that companys acid (quick) test ratio is at 1:1 while the loan is outstanding . Simplified acid test ratio is given by (Surplus cash on hand after production + account receivable) / (bank borrowings + interest accrued) iv. make sure that needed funds are made available for meeting production costs. Formulate this problem as an LP model. 2. Most recent audited summarized balance sheet of shop financial services is given below: The company intends to enhance its investment in the lease portfolio by another Rs.1000 lakh. For this purpose it would like to raise a mix of debt and equity in such a way that the overall cost of raising additional funds is minimized. The following constraints apply to the way the funds can be mobilized: a) Total debt divided by net owned funds cannot exceed 10. b) Amount borrowed from financial institutions cannot exceed 25% of the net worth. c) Maximum amount of bank borrowings cannot exceed three times the net owned funds d) The company would like to keep the total public deposit limited to 40% of the total debt. The post tax costs of different sources of finance are as follows

Equity = 2.5%, Term Loans = 8.5% , Public Deposits = 7%, Bank Borrowings = 10% Liabilities Rs. Lakh Assets Rs. Lakh Equity Share 65 Fixed Assets: Capital Reserves and 110 Assets on lease 375 Surplus (original costs 550 lakhs) Term loans from 80 Other fixed assets 50 IFCI Public Deposits 150 Investments on 20 wholly owned subsidiaries Bank Borrowings 147 Current Assets: Other Current 50 Stocks on hire 80 Liabilities 602 Receivables 30 Other current assets 35 Miscellaneous 12 expenditure (not written off) 602 Note Total debt = term loan from financial institution + public deposits + bank borrowings Net worth = equity share capital + reserves and surplus Net owned funds = net worth miscellaneous expenditures 3. A person is interested in investing Rs. 500000 in a mix of investments. The investment choices and expected rates of return on each one of them are : Investment Mutual Fund A Mutual Fund B Money Market Fund Government Bonds Shares Y Shares X Projected rate of return 0.12 0.09 0.08 0.085 0.16 0.18

The investor wants at least 35% of his investment in government bonds. Because of the higher perceived risk of the two shares, he has specified that the combined

investment in these not to exceed Rs.80000. The investor has also specified that at least 20 % of the investment should be in the money market fund and that the amount of money invested in shares should not exceed the amount invested in mutual funds. His final investment condition is that the amount invested in mutual fund A should not be more than the amount invested in mutual fund B. The problem is to decide the amount of money to invest in each alternative so as to obtain the highest annual total return. Formulate the above as linear programming problem.