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Capital Budgeting: Financial Appraisal of Investment Projects

Don Dayananda, Richard Irons, Steve Harrison, John Herbohn, Patrick Rowland

Chapter 12

More advanced linear programming concepts and methods - all with Video Answers

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Chapter Questions

Problem 1

With regard to Example 12.1:
(a) solve this problem using MILP, with each generation project specified as a binary activity;
(b) solve the problem using MILP, with the requirement that only one natural gas project can be selected, and at least two of the windfarm, biofuel and solar panel projects should be included.

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Problem 2

Suppose in Example 12.5 that the manufacturer wishes to restrict the selection to only two product lines, and that either hockey or baseball equipment is to be included in the optimal plan. Modify the model and determine which product lines constitute the optimal mix.

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10:45

Problem 3

A gas company is planning a natural gas export project. This involves three component projects, namely to develop the gas field, construct a pipeline to a large coastal city, and develop a gas liquidification and export facility at the end of the pipeline. In the first case, gas would be sold on-site to another company. If the pipeline is constructed, the company could find domestic markets for all its production. A gas liquidification and export facility would allow substantially higher gas prices to be obtained through exporting. $$\$ 160 \mathrm{M}$$ is available for investment. Gas-field development would cost $$\$ 50 \mathrm{M}$$, pipeline construction $$\$ 60 \mathrm{M}$$, and development of a liquidification plant and an export facility $$\$45M$$. Respective NPV payoffs are $$\$20M$$ if gas is sold on-site, $$\$ 10 \mathrm{M}$$ for sales domestically and $$\$ 30 \mathrm{M}$$ if gas is exported. Set up a MILP model and solve this problem, taking account of the contingency relationship between the three component projects.

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Jacquelyn Trost
Numerade Educator

Problem 4

A fisherman is considering expansion of his operations. He has the opportunity to purchase a new fishing boat and net licence, to set up an on-shore fish processing depot and to build a fish canning operation. His current scale of operation does not warrant setting up the processing plant. The canning operation cannot proceed unless on-shore processing is carried out. The net present values for the three projects are $$\$ 2 \mathrm{M}$$, $$\$ 1 \mathrm{M}$$ and $$\$ 1.5 \mathrm{M}$$. Year 1 and year 2 capital outlays for the new boat and licence are $$\$ 400,000$$ and $$\$ 200,000$$, for the processing plant $$\$ 300,000$$ and $$\$ 300,000$$, and for the canning plant $$\$ 200,000$$ and $$\$ 300,000$$. The fisherman has $$\$ 800,000$$ in cash reserves, and can borrow money in years 1 and 2 , of up to $$\$ 1 \mathrm{M}$$ in total, at a $12 \%$ interest rate. Set up these investment opportunities as a linear programming model, and determine the optimal investment portfolio.

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Problem 5

A developer is planning to construct a new five-star hotel on a prime inner city site. Three alternative design and size options are under consideration, with net capital
$$
\begin{array}{lccc}
\hline \hline & \text { Design 1 } & \text { Design 2 } & \text { Design 3 } \\
\hline \text { Capital expenditure, EOY 0 (\$M) } & 2 & 5 & 3 \\
\text { Capital expenditure, EOY 1 (\$M) } & 12 & 15 & 11 \\
\text { Capital expenditure, EOY 2 (\$M) } & 4 & 6 & 8 \\
\hline \hline
\end{array}
$$
outlays in the first three years as shown in Table 12.8, after which the hotel should be self-funding.

The developer has $$\$ 20 \mathrm{M}$$ in readily available funds, and can borrow further finance of up to $$\$ 5 \mathrm{M}$$ at an interest rate of $14 \%$. The three designs have estimated net present values over twenty years of $$\$ 10 \mathrm{M}$$, $$\$ 17 \mathrm{M}$$ and $$\$ 9 \mathrm{M}$$. Set up a linear programming model which can be used to assist in project choice.

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