Name:

Instructions: The exam is composed of 3 exercises. The maximum grade is 100. The total allotted time is 80 minutes. You are required to clearly and thoroughly show the steps followed to reach the nal solution for each one of the exercises, i.e., providing only the nal answer is not enough. Academic Dishonesty: the IE Code of Ethical Conduct will be enforced to deal with any case of dishonesty.

(25%)

1. A 10-acre slum in New York City is to be cleared. The ofcials of the city must decide on the redevelopment plan. Two housing plans are to be considered: low-income housing and middle-income housing. The types of housing can be developed at 20 and 15 units per acre, respectively. The unit cost of the low and middle income housing are $13,000 and $18,000. The lower and upper limits set by the ofcials on the number of low income housing units are 16 and 100. Similarly, the number of middle income housing units must lie between 30 and 70. The combined maximum housing market potential is estimated to be 150 (which is less than the sum of the individual market limits, due to the overlap between the two markets). The total mortgage committed to the renewal plan is not to exceed $2 millions. Finally, it was suggested by the architectural adviser that the number of low-income housing units be at least 50 units greater than one half of the number of the middle-income housing units. Develop a linear programming model aimed at minimum cost renewal planning. Write down the relevant parts of the model, as indicated below. i. List of Decision Variables Solution: x1 = number of low-income housing, and x2 = number of middle-income housing. ii. Objective Function Solution: min iii. List of Constraints Solution: x1 + x2 150 x1 50 + 0.5x2 13, 000x1 + 18, 000x2 2, 000, 000 16 x1 100 30 x2 70 (1/20)x1 + (1/15)x2 10 x1 , x2 0 z = 13, 000x1 + 18, 000x2

(30%)

2. Beer Company manufactures pale ale and stout from corn, hops and malt. At present, 40 kg of corn, 30 kg of hops, and 40 kg of malt are available. A barrel of pale ale sells for $40 and requires 1 kg of corn, 1 kg of hops and 2 kg of malt. A barrel of stout sells for $50 and requires 2 kg of corn, 1 kg of hops and 1 kg of malt. Beer Company can sell all pale ale and stout that is produced. Assume that Beer Companys goal is to maximize total sale revenues. The mathematical model and the Excel Solver solution to the problem are provided below, where x1 and x2 represent the amount of pale ale and stout produced in barrels, respectively.
Adjustable Cells Cell $B$5 $C$5 Name Quantity Pale Ale Quantity Stout Final Reduced Objective Allowable Value Cost Coefficient Increase 13.33333333 0 40 60 13.33333333 0 50 30 Allowable Decrease 15 30

max

z= s.t.

40x1 + 50x2 x1 + 2x2 40 x1 + x2 30 2x1 + x2 40 x1 , x2 0

Constraints Cell Name $D$10 Corn Used $D$11 Hops Used $D$12 Malt Used Shadow Constraint Allowable Price R.H. Side Increase 40 20 40 10 26.66666667 0 30 1E+30 40 10 40 10 Final Value Allowable Decrease 20 3.333333333 20

Without re-running solver and based exclusively on the sensitivity report, provide answers to the following questions: (a) (5%) Provide the optimal production mix and the associated sale revenues. Solution: x = x = 13.33, and z = 40 13.33 + 50 13.33 = 1200. 1 2 (b) (5%) What is the new optimal solution (including the new optimal sale revenue) if the unit price of pale ale becomes $50? How did you reach your conclusion? Solution: Since the increase (50-40=10) on the coefcient is within the allowable increase (60) for pale ale, the optimal quantities remain the same. Then the optimal sale revenue becomes z = 50(13.33+ 13.33) = 1333. (c) (5%) How much should the company be willing to pay for one extra kilo of malt? What is the maximum number of kilos that can be bought at that price? Solution: According to the shadow price for malt, for every kilo of malt supply increase, the company is going to earn $10 more, therefore, the company will be willing to pay for maximum $10 for that. On the other hand, according to the allowable increase for malt, the maximum number of kilos that can be bought at that price is 10. (d) (5%) How many extra corns is the company willing to buy? What is the maximum price per kilo? Solution: According to the shadow price for corn, for each kilo of corn supply increase, the sale revenues increase $20, as long as the increase is within 10 kilos. Therefore, the company is willing to pay maximum $20 per kilo for maximum 10 kilos. (e) (10%) Let us now consider the possible production of a third type of beer, lager. A barrel of lager would require 2 kg of corn, 2 kg of hops, and 1 kg of malt. What is the least amount of price that we should set to consider producing this type of beer?

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Solution: The production of lager will decrease the raw material supply for the other two types of beer, and therefore the sale revenues for pale ale and stout will be decreased. First, lets check whether the same sensitivity report can be used. By 2 1 2 + + < 1, 20 3.33 20 this is veried. And according to the shadow prices for corn, hops and malt, the decrease on the sale revenue for pale ale and stout can be calculated as 2 20 + 2 0 + 1 10 = 50. Therefore, the least amount of price we should set equals 50.

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(45%)

3. Dante Alighieri Corporation is being sued by Virgilio. Virgilio can settle out of court and win $40,000, or go to court. If Virgilio goes to court, there is a 30% chance that he will win the case. In case he wins, he will get a settlement of $175,000; and otherwise, he gets nothing. (a) (5%) If Virgilio is risk neutral, what should he do, settle out of court or go to court? Solution: We calculate Virgilios expected prot from settling out of court, EV1 , and from going to court, EV2 . EV1 EV2 = = 40000, 0.3 175000 + 0.7 0 = 52500.

Since EV2 > EV1 , Virgilio should go to court. (b) (5%) If Virgilio is risk averse and has a utility function of u(x) = x0.9 , what should he do?1 Solution: We calculate Virgilios expected utility from settling out of court, Eu1 , and from going to court, Eu2 . Eu1 Eu2 = = 400000.9 = 13862.8969, 0.3 1750000.9 + 0.7 0 = 15698.4039

Since Eu2 > Eu1 , Virgilio should still go to court. (c) (10%) Now suppose Virgilio is risk averse and has a utility function of u(x) = xb , where b < 1 is unknown. Given the settlement if he wins, he asks for at least $50,000 to settle out of court. Based on these facts, specify a way to gure out the value of b. Solution: Virgilios respective expected utilities now equal Eu1 Eu2 = = 50000b , 0.3 175000b .

When the settlement out of court equals $50000, Virgilio is indifferent between going to the court and settling out of court, therefore, Eu1 = Eu2 , in particular, 50000b = 0.3 175000b . We can solve b from the above equation. (d) (20%) Virgilio can hire a consultant for $25,000 who will predict who will win the trial. Based upon historical data, we know that the consultant is correct 90% of the time. Whats Virgilios optimal strategy here? In particular, whether Virgilio should hire the consultant and whether he should go to court?
1 For

the ease of calculation, 40, 0000.9 = 13862.8969, 175, 0000.9 = 52328.013.

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Solution: Dene the following events: W = win court, L + = lose court; = predict win,

- = predict lose. We know the following probabilities: P(W) = 0.3, P(+| W) = P(-| L) = 0.9, P(L) = 0.7; P(-| W) = P(+| L) = 0.1.

Virgilio needs to make decisions at two stages: rst, whether to hire the consultant, and second, whether to go to court. The following strategies can be considered: 1. No consultant and settle out of court. 2. No consultant and go to court. 3. Hire consultant, go to court when predict win, and settle out of court when predict lose. 4. Hire consultant, go to court when predict lose, and settle out of court when predict win. 5. Hire consultant, and always settle out of court. 6. Hire consultant, and always go to court. And the following joint probabilities can be calculated: P(W +) = = P(W -) = = P(L +) = = P(L -) = = P(+| W) P(W) 0.9 0.3 = 0.27 P(-| W) P(W) 0.1 0.3 = 0.03 P(+| L) P(L) 0.1 0.7 = 0.07 P(-| L) P(L) 0.9 0.7 = 0.63

Strategy 5 and 6 are inferior to Strategy 1 and 2 since the same action is taken but with the extra cost for the consultant, and weve already calculated expected values for Strategy 1 and 2, so lets consider Strategy 3 and 4. The respective expected values are as follows.

EV3 EV4

= =

175000 0.27 + 0 0.07 + 40000 0.03 + 40000 0.63 25000 = 48650 40000 0.27 + 40000 0.07 + 175000 0.03 + 0 0.63 25000 = 6150

Since EV2 = 52500 yields the largest expected value, Virgilio should not hire the consultant and go to the court.

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(e) (5%) If Virgilio is able to negotiate the price with the consultant, what is the maximum price he is willing to pay? Solution: Let the price for the consultant be x, then for EV3 EV2 , we have x 21150, i.e., the maximum price Virgilio is willing to pay is $21150.

Prediction Win Win Lose Lose

Table 1: Strategy 3 Court Outcome Win 175000 25000 Lose 0 25000 Win 40000 25000 Lose 40000 25000

Probability Prob(W+)=0.27 Prob(L+)=0.07 Prob(W-)=0.03 Prob(L-)=0.63

Prediction Win Win Lose Lose

Court Win Lose Win Lose

Table 2: Strategy 4 Outcome 40000 25000 40000 25000 175000 25000 0 25000

Probability Prob(W+)=0.27 Prob(L+)=0.07 Prob(W-)=0.03 Prob(L-)=0.63

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