Introduction:

Definition of Goal Programming

Difference of Goal Programming from other OR methods

Definition of the Terms:

Goal constraints
Deviation Variables

APPLICATIONS OF GOAL PROGRAMMING IN INSURANCE

A. CAPITAL BUDGETING
Capital Budgeting, an investment decision-making, is a method for evaluating,
comparing, and selecting projects to achieve the best long-term financial return of
companies or businesses.
One of the objectives of capital budgeting is to evaluate each opportunity that can
help a company to avoid any damaging scenarios for ones business in the future. Hence,
goal programming is one of the best tools in solving a capital budgeting problem since
goal programming is known as a technique for solving multiple objective decision
making problem in which it allows decision-maker/s throughout the decision making
process.
Example: The company is relatively small, with after tax earnings of Rs. 520.00 for the
year which just ended. Since there are Rs. 120,000 shares outstanding the earnings per
share were Rs. 5.00. The management estimates earnings for the current year before any
new investments to be Rs. 500,000 or Rs. 5.00 per share. Since they desire a 6 per cent
growth in Earnings per Share (EPS), the management feels a 40 percent dividend payout
ratio is appropriate with this company background information.
Table 1: Companys Information
1. Current Data:
Actual Earning after Taxes Last year
Number of Shares Outstanding
Earning Per Share
Each Available for investments and dividends
Estimated earnings for current year w/o New Investment
Estimated each flow for current year w/o New Investment
2. Goals and Requirements for Current Year
Earnings per share-minimum (6% increase)
Total Earnings Required
Less: Estimated earnings without new investments
Incremental earnings required from new investments
Cash Flow required minimum
Less estimated cash flow without new investment
Increment cash flow required from new investments
Minimum R & D expenditures
Minimum Necessary expenditures
Minimum dividends of last years earnings (4% of earnings)
Cash available for new investments
Less: R & D expenditures

Rs. 520,00
Rs. 110,000
Rs. 10
Rs. 1,400,00
Rs. 500,000
Rs. 1,150,000
Rs. 1,060
Rs. 550,000
Rs. 500,000
Rs. 70,000
Rs. 1,500,000
Rs. 1,150,000
Rs. 180,000
Rs. 500,000
Rs. 70,000
Rs. 210,000
Rs. 500,000
Rs. 500

Necessary Expenditures
Dividends
Net Cash Available for new investments

Rs. 70,000
Rs. 210,000
Rs. 640,000

Table 3: Summaries of Investment Opportunities

Initial Investments
(Rs. 1000s)

100

300

200

300

200

1st years
accounting income
(Rs. 1000s)
st
1 year cash flow
(Rs. 1000s)
Internal rate of
Return

15

20

30

25

25

40

40

130

100

65

30.4 %

45.6 %

13.5 %

24.2 %

22.2%

GOAL PROGRAMMING MODEL FORMULATION

Objective Function: (measured in Rs 1000s)
Maximize Z = 0.304 P1X1 + 0.456 P2X2 + 0.134 P3X3 + 0.242 P4X4 + 0.222 P5X5
Where Xis represent the amount of funds committed to project j (Pj) and the
coefficients proceedings each x1 stand for the project IRRs shown in Table 3.
CONSTRAINTS
A. Goal Constraint
X1 + X2 + X3 + X4 + X5 + d1 d1+ = 640
Where dI is the negative deviation variable and dI+ is the positive deviation variable

Note: The amount allocated to all projects cannot exceed Rs. 640,000 the total amount
available.

B. Project Constraint

0 X1 110
0 X2 110
0 X3 110
0 X4 110
0 X5 110
Note: The commitment of funds to any one project should be a non-negative integer and
cannot exceed the projects maximum required funds
C. Earnings Constraint
15
X
100 1 +

20
X
300 2 +

30
X
200 3 +

25
X
300 4 +

25
X + d d + = 70
3
3
200 5

Note: To get the Earnings Constraint, divide First years Accounting Income over the
Initial Investment per project (See Table 3). The earning cannot exceed the amount of
the incremental earnings required from new investment.

D. Cash Flow Constraint

40
X
100 1 +

40
X
300 2 +

130
X
200 3 +

100
X
300 4 +

65
X + d d + = 180
4
4
200 5

Note: To get the Cash Flow Constraint, divide First years Cash Flow over the Initial
Investment per project (See Table 3). The earning cannot exceed the amount of the
incremental cash flow required from new investment.

GOAL PROGRAMMING MODEL:

Maximize Z = 0.304 P1X1 + 0.456 P2X2 + 0.134 P3X3 + 0.242 P4X4 + 0.222 P5X5
Where Xis represent the amount of funds committed to project j (Pj)
subject to
Goal Constraint: X1 + X2 + X3 + X4 + X5 + d1 d1+ = 640
Project Constraint:

Earnings Constraint:

15
X
100 1 +

0 X1 110
0 X2 110
0 X3 110
0 X4 110
0 X5 110
20
30
X
X
300 2 + 200 3

25
X
300 4 +

25
X +
200 5

d3

d3+ = 70
Cash Flow Constraint:
d4+ = 180

40
X
100 1 +

40
X
300 2 +

130
X
200 3

100
X
300 4 +

65
X +
200 5

d4

Results and Conclusion:

References:
Subbiah,V., Babu,G.,Sahrma,S.D.(2011), Capital Budgeting through Goal Programming,
International Journal of Applied Mathematics and Applications. Vol.3(2).pp 145 -151
Nikbakht,E., Groppelli,A.A.(1986) Capital Budgeting. Finance (6th Ed.).Hauppauge, NY:
Barrons Educational Series, Inc.