Homework Problem Set #3

1. EndRun Construction Company

Topics: Capital budgeting, integer programming

Difficulty: Low

The EndRun Construction Company is evaluating capital investment possibilities in five

infrastructure projects. Each project entails different cash outlays and returns now and over the
next four to five years. The table below contains the company’s cash flow projections in millions
of US dollars for the five projects (where negative numbers are outflows), including the NPV for
each project at the hurdle rate of 10%.

Project 1 2 3 4 5
Year 0 (now) (900) (50) (700) (1,200) (300)
Year 1 (800) 500 (400) 350 (950)
Year 2 500 (500) 350 390 700
Year 3 600 90 490 580 600
Year 4 720 (160) 450 620 500
Year 5 840 - 510 - 150
NPV @ 10% 250 -50 218 300 300

The company has an annual capital budget of $2 billion for now and for each of the next five years
(which means that the net cash outflow for the chosen projects must not exceed $2 billion in any
year). Each project must be either fully invested in or not selected at all.

(a) Formulate but do not solve an IP model to determine the projects that EndRun should
select for investment in order to maximize the NPV. Be sure to define your decision variables.

(b) The optimal solution, it turns out, is to select Projects 1, 2, 3, and 5. Comment briefly on why
the optimal solution includes a negative NPV project (Project 2).

Decision Models and Uncertainty Page 1 BITSoM Term I, 2021

 Homework Problem Set #3
2. The Box Problem

Topic: Multi-item production with substitution, production setups, IP formulation

Difficulty: Medium to high

A company sells seven types of boxes, ranging in volume from 17 to 33 cubic feet. The demand
and size of each box are given in the following table.

Box Type
1 2 3 4 5 6 7
Size (cubic feet) 33 30 26 24 19 18 17
Demand 400 300 500 700 200 400 200

The variable cost (in dollars) of producing each box is equal to the box’s volume. A fixed cost of
$1,000 is incurred to produce any quantity of a particular box. If the company desires, demand
for any type of box can be satisfied by a box of a larger size.

Formulate but do not solve an IP model to determine the minimum cost of meeting the demand
for boxes. Be sure to define your decision variables. Your objective function and constraints
must be linear functions; do not multiply decision variables by each other.

Decision Models and Uncertainty Page 2 BITSoM Term I, 2021