Session 4 A Product Mix decisions with capacity

constraints, and Linear Programming

Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
Learning Objectives
1. Know how to choose which products to produce when
there are capacity constraints
2. Understand the usefulness of the linear programming (LP)
technique for business managers
3. Formulate business planning problems as LP models that
are subject to one or multiple constraints
4. Solve LP problems by the graphic and the trial-and-error
approach
Product Mix Decisions

Product-mix decisions
 which products to sell and in what quantities.
 choose the product that produces the highest contribution
margin per unit
 Product-Mix Decisions with Capacity Constraints

 What about there are limiting or scarce factors that restrict

output?
Example

Product A B C

Contribution per unit $12 $10 $6

Machine hours per unit 6 2 1

Estimated sales demand (units) 2 000 2 000 2 000

Capacity for the period is restricted to 12 000 machine hours.

Which product to product first? Please rank…

 Product-Mix Decisions with Capacity Constraints

Example
Components A B C
Contribution per unit $12 $10 $6

Machine hours per unit 6 2 1

Estimated sales demand (units) 2 000 2 000 2 000
Required machine hours 12 000 4 000 2 000

Contribution per machine hour $2 $5 $6

Ranking per machine hour 3 2 1

Capacity for the period is restricted to 12 000 machine hours.

 Choose product that yields the largest contribution per limiting factor, and the
second.. When there is still capacity of the constraints.
 Product Mix Decisions with Capacity Constraints

 the decisions managers make about which products to sell and in what
quantities.
 Usually have only a short-run focus
 Typically, it can be relaxed in the long run.
 How to determine product mix?
 Maximize operating income, subject to constraints (e.g. capacity, sales
demand)
 Assumptions:
 No of units can be in fraction
 the only costs that change are costs that are variable with the number of
units produced (and sold).
 Thus, use individual product contribution margins to identify optimal product
mix that maximizes operating income.
 Quiz on Product-Mix Decisions with Capacity Constraints

A company has the following production planned for the next four weeks. The figures reflect
the full capacity level of operations. Planned output is equal to the maximum demand per
product. The direct labour force is threatening to go on strike for two weeks out of the
coming four. This means that only 2160 hours will be available for production rather than
the usual 4320 hours. If the strike goes ahead, which product or products should be
produced if profits are to be maximized?

A Company has the following Production Plan for the month

A B C D
$ per unit $ per unit $ per unit $ per unit

Selling Price 160 214 100 140

Raw Material Cost 24 56 22 40
Direct Labour Cost 66 88 33 22
Variable Overhead Cost 24 18 24 18
Fixed Overhead Cost 16 10 8 12

Profit 30 42 13 48

Planned Output 300 125 240 400

Direft Labour Per unit 6 8 3 2

 Answer to Quiz
A Company has the following Production Plan for the month
A B C D
$ per unit $ per unit $ per unit $ per unit

Selling Price 160 214 100 140

Raw Material Cost 24 56 22 40
Direct Labour Cost 66 88 33 22
Variable Overhead Cost 24 18 24 18
Fixed Overhead Cost 16 10 8 12

Profit 30 42 13 48

Planned Output 300 125 240 400

Direct Labour Per unit 6 8 3 2

Contribution Margin 46 52 21 60

Contribution Margin Per

Labour Hour 7.67 6.50 7.00 30.00

Ranking 2 4 3 1.00

Total Labour Hours used 800.00

Available labour hour 2,160.00

after strike

Available labour hour for =1360/6 1,360.00

2nd highest Contribution
Margin
Units produced for A 226.67
Still not all output fulfilled
 Linear Programming
 What about if there are more than one constraint/scarce resources?
 Linear programming can be used
 Optimum output can be determined using a two-dimensional graph if 2
products are used.
 If no of products > 2, the optimal output can be determined using a non-
graphical approach, the simplex method.
 LP : a technique for making decisions under certainty
 i.e. when all the courses of options available are known
 the objective of the firm along with its constraints are quantified
 Choose course of action out of all possible alternatives which yields
the optimal results.
 Linear programming
 A mathematical technique to determine how to use limited resources
to achieve optimum benefits.
 Seeks to find a feasible combination of output that will maximize or
minimize the objective function
 In the form of maximizing profits or minimizing costs.
 Assume relationships to be linear and where an optimal solution
exists.
 Assume that the contribution per unit for each product and the
utilization of resources per unit are the same within the output range
being considered
Linear programming – Example
• A Company is making two products, Y & Z and the standards per unit of
products are as follows:

The standards per unit

Product Y $ $ Product Z $ $

Standard selling price 110 Standard selling price 118

Less Stardard cost: Less Stardard cost:
Material (8 units at $ 4) 32 Material 4 units at $ 4) 16

Labour (6 hours @ $10) 60 Labour (8 hours @ $10) 80

Variable Overhead (4 Variable Overhead 6 machine

machine hour at 1) 4 96 hour at 1) 6 102

Contribution 14 Contribution 16
Linear programming – Example
For the following period, the availability of resources are expected to be subject to the
following limitations:

Labour 2.880 hours

Material 3,400 units

Machine capacity 2,760 units

The marketing manager estimates that the maximum sales potential for product Y is limited
to 420 units. There is no sales limitation for product Z.

Required

You are asked to advise how these limited facilities and resources can best be used to gain
the optimum benefit from them.
Linear programming – Example
 Y = No of units of product Y

 Z = No of units of product Z

 C is to maximize the Contribution

 How do we formulate the LP Model?

Linear programming – Example
 Y = No of units of product Y

 Z = No of units of product Z

 C is to maximize the Contribution

 Maximize C = 14 Y+ 16 Z subject to the following constraints:

 8Y + 4 Z <= 3,440 (material constraint)

 6Y+8Z <= 2,880 (Labour Constraint)

 4Y + 6Z <= 2,760 (Machine capacity constraint)

 0 <= Y <= 420 (maximum and minimum sales limitation)

 Z >= 0 (minimum sales limitation)

Material Constraint
 8Y + 4 Z <= 3,440 (material constraint);

 How do we draw the line?

 When Y = 0, Z = 860

 When Z = 0, Y = 430
Labour Constraint
 Labour constraint 6Y + 8Z  2 880

 How do we draw the line?

 When Z = 0, Y = 480;
 When Y = 0, Z =360
Machine Capacity Constraint
 Machine capacity constraint 4Y + 6Z  2 760
 How do we draw the line?

 When Z = 0, Y = 690;
 when y = 0, Z = 460
Limitation of Output of Product Y
 Constraint Imposed by sales limitation of Product Y

 Y  420
Optimal Solution
 Putting all the lines together
 Optimal Output – Trial & Error
 What if C = 2,240?

 Y = 160 units ($2,240/$14) at $ 14 contribution per unit

 Or 140 units of Z ($2,240/$16) at a contribution of $ 16 per unit.

 Extend to the right until it touches the last corner of the boundary of ABCDE, i.e. Point C

 Y = 400 units (Contribution of $ 5,600) Plus 60 units of Z (Contribution $ 960) = $ 6,560

Solving the simultaneous equations
 Solving the simultaneous equations for the Optimal point C:

Remember:

 8Y+4Z = 3,440

 6Y+8Z = 2,880

So, 16Y+8Z = 6,880

 6Y+8Z = 2,880

 And 10 Y = $4,000

 Y= 400

 Z=60

 i.e. (16 x 400) + 8Z = 6,880

Premium to pay to remove Constraints
 What are the constraints that are binding at point C?

 Material and Labour

 What does this mean?

 What about if we could remove these constraints, how much we are willing
to pay?
 Consider the optimal Use from an additional unit of a scare resource, i.e.
Marginal Contribution
Marginal Contribution from Material
 Marginal Contribution from obtaining extra unit of material
 8Y+4Z = 3,441 (revised material constraint)
 6Y+8Z= 2,880 (no change for labour constraint)
 Y = 400.2 units, Z=59.85 units

 Initial optimal output was Y = 400 units; Z = 60 units

 Now that Y increased by 0.2 unit and Z decreased by 0.15 unit;
 Extra contribution is $ 0.4; the price you are willing to pay one extra
unit of material
Marginal Contribution from Labour
 Marginal Contribution from obtaining one extra labour hour
 8Y+4Z = 3,440 (no change for material constraint)
 6Y+8Z= 2,881 (revised labour constraint)
 Y = 399.9 units, Z= 60.2 units

 Initial optimal output was Y = 400 units; Z = 60 units

 Now that Y decreased by 0.1 unit and Z increased by 0.2 unit;
 Extra contribution is $ 1.8; the price you are willing to pay for one
extra labour hour
LP - Walk Through an Example
 Company P makes two products: the X and the Y. Each X generates £12 of contribution and each
Y generates £10. The following resources are limited:

 Material. There is only 540kg of material available each week. Each X uses 12kg and each Y uses
9kg.

 Each X takes 4 hours to build and each Y takes 5 hours. There are 5 men working 40 hours each
per week. There is no spare capacity elsewhere in the business, so the labour is limited.

 Machine hours are also limited. At present there is just one machine, also capable of running for
40 hours per week. Each X requires 30 minutes and each Y takes an hour and a quarter of
machine time.

 The first step in a finding a solution to a linear programming problem is to determine the variables.
Which of the following is correct for determining the variables for the given scenario?

 A

 Let X = Number of X Made

 Let Y = Number of Y Made

 B

 Let X = amount of material used

 Let Y = amount of labour hours used

 Let Z = amount of machine hours used

Specify Objective Function
 Once you have determined the variables, the next step is to construct the objective
function.

 What is the objective function for the scenario?

Minimize cost, which is:

 12X + 9Y ≤ 540

 4X + 5Y ≤ 200

 0.5X + 1.25Y ≤ 40

 Maximize contribution, which is:

 12X + 10Y
Specify the Constraints
 Now we have determined the variables and constructed the objective
function, the next step is to specify the constraints.

Which of the following is correct for the scenario?

A
 Material: 12X + 9Y ≤ 540
 Labour: 4X + 5Y ≤ 200
 Machine: 0.5X + 1.25Y ≤ 40

B
 Material: 12X + 9Y = 540
 Labour: 4X + 5Y = 200
 Machine: 0.5X + 1.25Y = 40
Non-Negativity
 It is important to also specify non-negativity.
 Which of the following is correct for the specification of non-
negativity in the linear programming solution?
A
 X,Y ≥ 0
B
 Material: 12X + 9Y ≥ 540
 Labour: 4X + 5Y ≥ 200
 Machine: 0.5X + 1.25Y ≥ 40
  
Draw The graph
• you are ready to draw the graph. The graph will show the lines at the boundary of the
constraints. To draw a line, you either need to know:

• 2 points

• 1 point and the gradient (slope) of the line

• To draw the graph from the information you have so far, the easiest method is to find two
points. One on the X axis for Y=0 and one on the Y axis for X = 0
Material
• Consider material first:

• 12X + 9Y ≤ 540

• Set the equation to

• 12X + 9Y = 540

• And then set X = 0 ; And then set Y = 0

• The two points will be:

• (0,45) and (60,0)

• (0,60) and (45,0)

Graph for Material
 Material Constraints
• There are several methods to work this out, but one way is:

• 12X + 9Y = 540

• 0X + 9Y = 540

• Y = 60

• This gives us the point (0,60)

• 12X + 9Y = 540

• 12 X + 0Y = 540

• X = 45

• This gives us the point (45,0)

• So far we have the graph above.

 Labour and Machining Constraints

• Now we need to add the lines for labour and machining.

• Labour: 4X + 5Y ≥ 200

• Machine: 0.5X + 1.25Y ≥ 40

• The key points are:

• Labour (0,50) and (40,0) Machining (0,80) and (32,0)

• Labour (0,40) and (50,0) Machining (0,32) and (80,0)

Feasible Region
 Feasible Region

• Which of the two lower graphs above is the feasible region?

• a. The whole pink area

• b. The purple line

Which of the graphs above represents the potential solutions?
a
b
Copyright

Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.