LINEAR PROGRAMMING

INTRODUCTION
 Key budget factors sometimes known
as a limiting factor or principal
budget factor.
 this a is, the factor which restricts
indefinite expansion or unlimited
profits.
 Where multiple (constraint) exists, a
mathematical technique known as
linear programming can be used to
 FUNDAMENTAL ASSUMPTIONS
1. The objectives and constraints (limiting
factors) are expressed as linear
functions / equations or inequalities.
2. There must be restriction in availability
or use of resources which are to be
allocated amongst the various
competing activities.
3. Certainty: It is believed that all relevant
information relating to a problem
situation are known, for example, the
resources available
 THE STEPS OF FORMULATING A
LINEAR PROGRAMMING
1. Determining the objective
variable and objective function
2. Constructing constraint
statements
3. Solve a multiple scarce resource
problem graphically
4. Establish feasible region
5. Determine optimal solution
EXAMPLE 1
 Hototri manufactures and sells
two products Nike and Puma. The
products both use the same type
of good quality wood (ash) which
can be difficult to source in
sufficient quantity. The supply of
ash is restricted to 5,400 kg per
period. Ash costs $40 per kg.
 The products are made by skilled
craftsmen (highly skilled labour)
who are well known for their
workmanship. The skilled craftsmen
take years to train and are difficult
to recruit. Hotori’s craftsmen are
generally only able to work for
12,000 hours in a period. The
craftsmen are paid $18 per hour.
 Hotori sells the products to a
large market. The company uses
specialized robot in the
production of the two product,
and in any period, up to 15,000
hours of nike and 12,000 hours of
puma are available.The selling
price for nike is $41 and the
selling price for puma is $69.
Manufacturing details for the two
products are as follows
Nike Puma
Craftsmen time per unit 0.5 hrs 0.75 hrs
Ash per product 270 g 270 g
Other variable cost $1.20 $4.70
 REQUIRED:

(a) Calculate the contribution/unit

earned from each product.
(b) Determine the optimal production
plan for a typical period assuming
that Hotori is seeking to maximise
the contribution earned.
EXAMPLE 2
 A machine shop makes boxes (B) and tins (T).

Contribution per box is $5 and per tin is $7. A

box requires 3 hours of machine processing

time, 16kg of raw materials and 6 labour hours.

A tin requires 10 hours of machine processing

time, 4kg of raw materials and 6 labour hours.

 In a given month, 330 hours of machine

processing time are available, 400kg of raw

material and 240 labour hours. The

manufacturing technology used means that

at least 12 tins must be made every month.

 Determine the optimal production plan if the
firm is seeking to maximize contribution
 The constraints are:
 3B + 10T ≤ 330
 16B + 4T ≤ 400
 6B + 6T ≤ 240
 T ≥ 12
 The optimal solution is found to be to
manufacture 10 boxes and 30 tins.
SHADOW PRICES
 Students to go research on this one.
SHORT TERM TACTICAL
DECISION MAKING
 The concept of relevant cost is very key in
making short term decisions
 Any cost that is useful for decision making is
often referred to as a relevant cost.
 Relevant costs are therefore future costs.
 A decision is about the future; it cannot
alter what has been done already.
 historic costs/sunk costs are irrelevant for
decision making.
 Relevant costs are cash flows:
 In essence, any cost or charge that fails to
reflect additional cash spending should be
excluded.
 These include: Depreciation as a fixed
overhead incurred.
 Relevant costs are incremental or
differential costs
 A relevant cost is one which arises as a direct
consequence of a decision
 Thus, only costs which will differ under some
or all of the available opportunities should
be considered.
MAKE OR BUY DECISIONS
 This type of situation arises when a
manufacturer is faced with the decision as to
whether:
(a) to manufacture one of its components in-
house, or
(b) to buy such components from an outside
supplier.
 qualitative factors will also be considered in
deciding whether or not to produce in-house:
 (a) The quality of the product that will be
bought from outside;
 (b) The reliability of the outside supplier;
 (c) The possible problems of transport and
handling costs; and
 (d) Government regulations, especially on
import from overseas.
DECISION CRITERIA

 (a) If the outside supplier’s quotation is

greater than the total variable cost of
producing the component in-house, then the
component should be manufactured in-
house.
 (b) If the total variable cost of in-house
production is higher than the quotation of
the outside supplier, then it will be quite
discrete for the management to purchase the
component from the supplier.
EXAMPLE
 Sky Heights Ltd manufactures components
for aircrafts. The following is the cost sheet
per unit of one of its component:
 Prime cost 30
 Variable costs 14
 Fixed costs 8
 Total cost 52
 The same component is available at $46 in
the open market. Report to the management
of Sky Heights whether the firm should
manufacture the component or buy it.
SOLUTION
 The variable relevant cost of making a
component is $44 whereas its market price is
$46. Hence, it is economical to manufacture
the component in-house.
EXAMPLE
 a firm is considering whether to
manufacture or purchase a particular
component 223.this would in batches of 10
000 units and the buying price is 6.50 per
unit. The marginal cost of manufacturing this
component is 4.75 per unit.
 The component would have to be made on a
machine which is currently working on a full
capacity. If it manufactured, it is estimated
that the sales of the finished product Z
would be reduced by 1000 units. Product Z
has a marginal cost of $60 per unit and sell
for $80 per unit.

 Should the firm manufacture or buy this

component.
SOLUTION (COST OF BATCH OF
10 000
 Marginal cost of manufacture 47500
 Lost contribution 20 000

 67500

Buying price 65 000

A saving of 2500 per ever batch of 10 000

CLOSING DOWN A PRODUCT LINE OR BUSINESS

 The general decision criteria, on financial

grounds, are that;
1.If a product or a division is making a positive
contribution towards common (general) fixed
costs, then it should not be closed.
2 If there are fixed costs specifically incurred
for a division or a product, then those fixed
costs become relevant costs and net
contribution should be calculated.
 EXAMPLE
 A Company produces three products for
which the following operating statements has
been produced.
X Y Z

SALES 32000 52 000 44 000

TOTAL COST 36 000 42 000 33 000

NET PROFIT (4000) 10 000 11 000

 Total cost comprise 2/3 variable ,1/3 fixed
 The directors consider that as product X
shows a loss it should be discontinued.
Required:
Based on the above cost data, should product X
be dropped. Motivate your answer.
SOLUTION
 students to provide to work out
ACCEPTANCE/REJECTION OF A
SPECIAL ORDER

 This type of situation arises when a company

receives an order from a customer at a price
lower than its normal selling price.
 The company, if working below capacity, may
be advised to accept the offer after taking
into consideration the marginal cost of its
production.
 Chaka Limited manufactures a special
product for ladies called ‘the slimming
stick‟. A stick sells for $0.20 per unit.
Current output is 400,000 sticks which
represents 80% level of activity. A customer
Gwaya Stores Limited, recently, placed an
order for 100,000 sticks at $0.13 per unit.
The total cost for the period were $56,000 of
which $16,000 were fixed costs. This
represents a total cost of $0.14 per slimming
stick.
 Required:
(a) Based on the above information, advise
Chaka Limited whether to accept or not to
accept the offer.
 Therefore if the answer to the following
questions are in affirmative, the special
price quoted by the customer should be
accepted:
 (a) Does the price quoted by the special
customer cover the marginal cost of
production?
 (b) Does the company have excess capacity?
SOLUTION
 Do we the capacity to take the order.
 What is our marginal cost.
 Does the offer price cover the marginal cost.
SOLUTION
 Current capacity-400 000 (80%)
 Spare capacity- 100 000 (20%)
 Total capacity -(500 00) (100%)

 Marginal cost =(56000-16 000)

 400 000
 0.10 per stick
 The offer price covers the marginal cost and
therefore should be accepted
EXAMPLE
The following information relates to G Ltd
Sales (100 000units @$2 each
Labour cost $80 000
Material cost $ 50 000
Fixed cost $30 000
An opportunity has risen to supply additional
units of 30 000 per year at price of $1.8
CONT
 Acceptance of this order would incur extra
fixed cost of $8 100 per annum and payment
of extra overtime premium of 20% for the
extra direct labour required.
REQUIRED
 Determine the net profit using marginal cost
principles
Should this order be accepted?
 The end
thank you