ACW2851 Accounting Information Systems and Financial Modelling

Lecture 5

Optimisation Models

Adapted from:
Beaman, Ratnutinga, Krueger, & Mudalige (2006) Financial Modelling (4th ed.)
Albright, Winston, & Zappe (2006) Data Analysis and Decision Making with Microsoft Excel (3rd ed.)
Powell & Baker (2007) Management science: the art of modeling with spreadsheets (2nd ed.)
Important
• International student attendance

2YQ85
Learning Objectives and link
to other topics
Sumproduct funtion

Q: What is the formula in C6?

Ans: =B3*B4+C3*C4+D3*D4
OR
Ans: =SUMPRODUCT(B3:D3,B4:D4)
• In sumproduct, excel takes the 1st cell in the 1st array
and multiply with the 1st cell in the 2nd array then add
with the 2nd cell in the 1st array and multiply with the
2nd cell in the 2nd array and so on.

• SUMPRODUCT(B3:D3,B4:D4) = B3*B4+C3*C4+D3*D4
• Note: red is the 1st array and blue is the 2nd array
 Optimisation Models
• use mathematical techniques to select an optimal
solution to a problem
– generates an answer (usually unique) that gives the best
value for the objective (either maximised or minimised)
• we must be able to specify in measurable terms:
– an objective function (such as profit maximisation, cost
minimisation; can have multiple objectives)
– the decision variables (changing cells)
– the constraints (limit the achievement of the objective)
such as nonnegativity, limited resources (such as
materials, labour, machine capacity, money), & limited
demand for products
 Optimisation Terms
• A feasible solution is any set of values of the
decision variables that satisfies all of the
constraints.
• The set of all feasible solutions is called the
feasible region/range.
• An infeasible solution is a solution where at
least one constraint is not satisfied.
• The optimal solution is the feasible solution
that optimises the objective function.
Optimisation Model Applications
• product mix (given scarce resources)
• portfolio management (given limited
funds & limited risk tolerance)
• resource budgeting
• input blending
• transportation modelling
• project scheduling
• inventory reordering policy
Steps in Solving an Optimisation Problem
1. Model development – decide what the objective is, what
the decision variables are, and which constraints are
required and how everything fits together
We need to first build the model layout, with all it’s input variables
and formulas, and then specify these “Solver Parameters”

2. Optimise – use Excel’s “Solver tool” to systematically

choose the values of the decision variables that make
the objective as large or small as possible and cause all
of the constraints to be satisfied
3. Perform sensitivity (or what-if) analysis using the
completed model
 Limitations of Optimisation Models
• only suitable for highly structured problems
• in specifying the constraints it is often
necessary to make assumptions which may
only be approximations
• sometimes involves complex mathematical
techniques not well understood by accountants
 Mathematical Techniques
Discussed in management science / operations
research reference books.
These include:
• linear programming
• nonlinear programming
• integer programming
• goal programming
• dynamic programming
• stochastic programming
• quadratic programming
 Maggie’s Dessert Problem
• Maggie decided she must plan her desserts carefully.
She will allow herself no more then 450 calorie and 25
grams of fat in her daily desserts. She requires at least
120 grams of desserts a day.
• She limits herself to two types of dessert, snack bars
and ice cream. Each has a “taste index” according to
her preference.
• See activity slide 10.<del>
• How much should she consume snack bars and ice
cream to stay within her constraints and maximizes the
total taste index of her dessert?
Source: Example 14.1 from Albright et. al.
Data for the two dessert products
Snack Bar Ice Cream
Details (per serving)
(X1) (X2)

Weight 37 grams 65 grams

Calories 120 calories 160 calories

Fat 5 grams 10 grams

Taste Index (0-100)

85 95
(Note: per gram)
 Linear Programming
• used when objective function AND constraints
are linear
• all parameters must be known with certainty
• all variables must have non-negative values
• Approaches we could take for our problems:
– Algebraic
– Graphical
– Using Excel’s “solver” add-in tool
 Algebraic Model
Identify the decision variables, write expressions
for the total taste index and the constraints in
terms of the x’s. Then add explicit constraints to
ensure that the x’s are nonnegative.
Maximize 37(85)x1 + 65(95)x2
Subject to:
120x1 + 160x2 ≤ 450
5x1 + 10x2 ≤ 25
37x1 + 65x2 ≥ 120
x1,x2 ≥ 0
Graphical Solution
 The Solution
First step is to identify appropriate decision
variables, the appropriate objective, the
constraints and the relationships between them.
<change>
– Objective – what you want to achieve. For example,
keywords are max profit, min costs, min time, and
max production.
– Decision variables – what you want excel to find out.
For example, keywords are determine xyz, how much
to produce, how many to buy etc.
– Constraints – what are things that stop you from
achieving your objective.
Lets build the model first
Maggie – lecture exercise

What is in Cell B18,

B19, B23, B31 etc?
Lets do optimisation
 Using Solver (1)

• To invoke Excel’s Solver, use the Data, Solver

command in Excel 2007 (or Tools, Solver in earlier
Excel versions).
• Note: if you don’t see a Solver option, speak to your tutor for
instructions to “add it in” to you Excel setup. See the following
slides for instructions
• File  Options
• Add-Ins  Excel
Add-ins
• Solver Add-Ins  OK
Solution to Maggie – lecture exercise
 The Solution
• The solution says that Maggie should consume
1.25 servings of snack bars and 1.875 servings
of ice cream per day.
• In this solution the calorie and fat constraints
are met exactly. We say they are binding.
• The constraint on grams is nonbinding since
the number of grams consumed is great than
the number required. The difference is called
slack.
Homework

• Pls try excel tutorial before class

Learning Objectives and link
to other topics