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7.1 Linear Programming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

This study unit is the second of three that concern quantitative methods, a major topic that has
been assigned a relative weight of 15% of Part 1. Examination candidates should expect
approximately 17 questions on various aspects of quantitative methods. The subject is tested at level
B, which means questions will have considerable rigor.
Below is a reprint of the IMA’s Learning Outcome Statements that are applicable to Study Unit 7.
After studying the outlines and answering the multiple-choice questions, you will have the skills
necessary to address the topics covered in the following statements:
Part 1 – Section D.2. Linear programming
The candidate should be able to:
demonstrate an understanding of the objectives of linear programming

define and identify the objective function

● demonstrate an understanding of the mathematical formulation of a constraint

● calculate the optimal solution by the use of linear programming using the graphical method
● list the benefits and shortcomings of linear programming
1. Linear programming is a technique used to maximize a revenue or profit function, or
minimize a cost function, subject to constraints, e.g., limited (scarce) resources or
minimum/maximum levels of production, performance, etc. In business, linear
programming is used for planning resource allocations. Managers are often faced with
problems of selecting the most profitable or least costly way to use available resources.
The advantage of linear programming is its applicability to many types of problems and its
usefulness for sensitivity analysis. A major disadvantage is the restrictiveness of its linear
assumptions, for example, that all costs are variable or fixed.
a. EXAMPLE: A manufacturer should minimize production costs while satisfying
production requirements, maintaining required inventory levels, staying within
production capacities, and using available employees. The objective function is the
production cost to be minimized; the constraints are production requirements,
inventory levels, production capacity, and available employees.
b. Other business applications include
1) Selecting a product mix
2) Blending chemical products
3) Scheduling flight crews
4) Assigning jobs to machines
5) Determining transportation routes

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2 SU 7: Linear Programming

c. Conditions that restrict the optimal value of the objective function are constraints.
1) A shadow price is the amount by which the value of the optimal solution of the
objective function in a linear programming problem will change if a one-unit
change is made in a binding constraint.
a)A nonbinding constraint is one that has excess capacity; i.e., the optimal
solution does not use all of the given resource. The shadow price for a
nonbinding constraint is zero because a one-unit change will not affect
the optimal solution when excess capacity exists.
b) The calculation of shadow prices is a simple example of sensitivity
analysis, which is any procedure to test the responsiveness of the
solution indicated by a model to changes in variables, alternative
decisions, or errors.
d. The unknowns used to construct the objective function and the constraints are the
decision variables. The values of the variables are limited by the constraints.
e. Values that are fixed for purposes of solving the model (but are not fixed forever) are
cost/profit coefficients for the objective function, technical coefficients for the
constraints, and the constants on the right-hand side of the constraints.
f. When the number of constraint equations equals the number of variables, a unique
solution exists. When the number of variables exceeds the number of constraint
equations, the number of possible solutions is usually infinite.
1)The values of the variables are the outputs from the linear programming
2) The constraint equations usually reflect the types of input or types of resources
being allocated, e.g., available machine hours or raw materials.
3) The objective of linear programming is to choose the best solution from a
potentially infinite number of possibilities.
2. Management accountants should recognize situations in which linear programming may be
applicable. When an application is attempted, qualified operations research experts should
assist in providing guidance in formulating and solving the problem. Linear programming is
a powerful planning tool for management that usually requires computer software.
3. Several methods are available to solve linear programming problems.
a. The graphical method, although the easiest technique, is limited to problems with two
b. The algebraic method is a trial-and-error technique. Pairs of constraints are solved
algebraically to find their intersection. The values of the decision variables are then
substituted into the objective function and compared to find the best combination.
1) The basic rule is that the optimal solution will be at the intersection of two or
more constraint equations.
2) Thus, all intersections can be computed and each solution evaluated in the
objective function to determine which solution is optimal.
c. The simplex method is the technique most commonly used to solve linear
programming problems. It is an algorithm to move from one corner solution to a
better corner solution. When a better solution cannot be found, the optimal solution
has been reached.
1) The simplex method relies on an area of mathematics called matrix algebra.
The equations that form the constraints are arranged in a matrix of coefficients
and manipulated as a group with matrix algebra.
2) Almost all practical applications of linear programming require the use of
computers. Most computer facilities have a linear programming package that
uses the simplex algorithm to find the optimal solution.

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SU 7: Linear Programming 3

4. EXAMPLE: A company produces products G and J. Product G contributes profits of $5,000

per unit sold, and product J contributes $4,000 per unit.
a. The company seeks to maximize profits, so the objective function is
Maximize 5G + 4J (the maximum profit in thousands of dollars)
b. The objective function is subject to the following constraints:
G + J> 5 (minimal production requirement)
G < 3J (market balance requirement)
10G + 15J < 150 (production capacity constraint)
G, J > 0 (nonnegativity constraint)
c. Graphical solution. To plot this set of constraints,
1) Change inequalities to equalities.
2) Plot the equalities.
3) Identify the correct side of the line for the original inequalities.








       ! "      

d. Algebraic solution. The combination of G and J that maximizes the objective

function will occur at one of the extreme points or corners of the feasible region.
1) Simultaneously solving the constraints intersecting at those corners and
substituting into the objective function,
a) At point A: G + J=5
–G + 3J = 0
4J = 5
J = 1.25 and G = 3.75
Profit = $5,000(3.75) + $4,000(1.25) = $23,750

b) At point B: G – 3J = 0 ————> 5G – 15J = 0

10G +15J = 150 + 10G + 15J = 150
15G = 150
G = 10 and J = 3.333
Profit = $5,000(10) + $4,000(3.333) = $63,333

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4 SU 7: Linear Programming

c) At point C: G = 0 (from nonnegativity constraint)

10G +15J = 150
J = 10 and G = 0
Profit = $5,000(0) + $4,000(10) = $40,000

d) Point D does not lie in the feasible region.

2) The firm should choose to produce at point B (10 of product G and 3.333 of
product J). This solution assumes that partial units of J may be produced. If
product J is produced in single units, the answer may be interpreted to be to
produce at a rate of 3 1/3 units in a given period.
5. Simplex Algorithm
a. A simplex algorithm is a systematic method of examining the corners (also called
vertices or extreme points) of the feasible region while in search of the optimal
solution. The algorithm always moves in the direction of improving the solution and
terminates at the optimal solution.
b. The algorithm proceeds in several iterations.
1) Iteration I seeks an initial corner. If no corner is found, the problem is
inconsistent, and the algorithm terminates.
2) Iteration II generates a set of corners adjacent to the initial corner (found in
Iteration I). The objective function will not become less optimal and will
ordinarily become more optimal at each successive corner.
3) The algorithm terminates after the optimal corner is reached.
c. EXAMPLE (adapted from a CPA question): The Wineroot Company manufactures two
garden benches, small and large. Each model is processed as follows:

Machining Polishing
Small (X) 2 hours 3 hours
Large (Y) 4 hours 3 hours
The available time for processing the two models is 100 hours a week in the
Machining Department and 90 hours a week in the Polishing Department. The
contribution margin expected is $5 for X and $7 for Y.
1) The objective function is the formula for the maximum total contribution margin.
Because each X produces a $5 CM and each Y produces a $7 CM, the total
CM will be 5X + 7Y. This is what Wineroot wants to maximize.
2) A constraint equation can be set up for the Machining Department, which has a
total of 100 hours available each week. Each X requires 2 hours of time from
that department, and each Y requires 4 hours. Accordingly, the total Machining
Department time taken by production is 2X + 4Y, which must be equal to or less
than the 100 hours available.
2X + 4Y < 100
3) The constraint equation for the Polishing Department is found in a similar
manner. The Polishing Department has a total of 90 hours available each
week. Each unit of X or Y requires 3 hours. Thus, the constraint for this
department is that 3X + 3Y must be equal to or less than 90.
3X + 3Y < 90
4) Both constraints are inequality expressions of the form less than or equal. To
transform them to an equality form, a positive variable called the slack variable
must be added to the left-hand side of each constraint.

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SU 7: Linear Programming 5

2X + 4Y < 100
2X + 4Y + S1 = 100
3X + 3Y < 90
3X + 3Y + S2 = 90

a) In general, each slack variable makes zero contribution to the value of the
b) Before the tableau is reconstructed, the linear programming problem may
be restated as follows:
Maximize 5X + 7Y + 0S1 + 0S2 subject to
2X + 4Y +1S1 + 0S2 = 100
3X + 3Y +1S2 + 1S2 = 90
If: X, Y, S1, S2 > 0
d. The initial simplex tableau (in its most common format) can be constructed from the
Wineroot Company’s LP problem. Rows run horizontally and columns run vertically.

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1) After the constraint equations are converted to equalities, construction of the

tableau begins with the variables row, which consists first of the constraint
variables (X and Y) and then the slack variables (S1 and S2). It is essentially a
row of labels.
2) The Cj row lists the payoff coefficients for a profit-maximizing problem (or the
cost coefficients for a cost-minimizing problem) given by the coefficients of the
objective function.
a) The slack variables have payoff/cost coefficients of 0.
b) Thus, in constructing this tableau, the Cj row consists of the coefficients
from the objective function (5X + 7Y + 0S1 + 0S2).
c) The Cj row is 5, 7, 0, 0.
3) The machining and polishing constraint rows in the simplex tableau are formed
from the constraint equalities, which were
2X + 4Y + 1S1 + 0S2 = 100
3X + 3Y + 0S2 + 1S2 = 90

a) Using these coefficients, the constraint rows (resource coefficient rows) are
2 4 1 0 100
3 3 0 1 90
b) The resource coefficient rows in the tableau must equal the constraints.

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6 SU 7: Linear Programming

4) There are as many basic variables as constraints.

a) Basic variables exist in the current tableau as a possible solution (not
necessarily optimal).
b) In this example, the initial basic solution sets S1 equal to 100 and S2 equal
to 90.
c) Nonbasic variables are the variables that are equal to zero in the current
solution, e.g., X and Y.
5) The basic variables are those that form an identity matrix. Their corresponding
variable columns consist of zeros and a single 1. The variable columns are
those beneath each variable, i.e., beneath X, Y, S1, and S2.
a) In the sample tableau, S1 has 1, 0 in its column, and S2 has 0, 1.
Consequently, they form an identity matrix.
b) In this tableau, the basic variables are also the slack variables.
But they may not necessarily be next to each other in other
6) The values for the basic variables are given in the right-hand side (RHS) column
of the tableau.
a) Because the entry 1 for the S1 variable is on the first row of the identity
matrix, the value of S is given in the first row of the RHS column as 100.
b) The entry of 1 for S2 is in the second row, and its value is found in the
second row under RHS to be 90.
c) The values 100 and 90 come from the right-hand side of the constraint
equations. Thus, the RHS values are also the amounts of available
7) The CB column consists of payoff (cost) coefficients of the basic variables in
profit-maximization (cost-minimization) problems.
a) Hence, the column consists of as many numbers as there are basic
variables (i.e., two for this tableau).
b) The numbers entered are the same as for the basic variables found in the
Cj row (0 and 0).
c) Zj and Cj – Zj are not part of the CB column.
8) The first element of the Zj row is the sum of the products of multiplying each
element in the CB column by each element in the first column [(0 × 2) + (0 × 3)
= 0].
a) The subsequent elements are obtained by multiplying each element in the
CB column by each element in the next column and adding the products.
b) For example, the third element in the Zj row is 0 [(0 × 1) + (0 × 0)].
c) The elements in the Zj row are opportunity costs.
9) The index row is the last (bottom) row. It provides a measure of the direction of
improvement of the objective function value for a corresponding change in the
a) It is obtained by subtracting each element in the Zj row from each element
in the Cj row.
Cj – Zj = 5 7 0 0
b) Positive elements in the index row for a maximization problem or negative
elements for a minimization problem indicate that the solution could be

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SU 7: Linear Programming 7

10) The current (but not the optimal) solution to this simplex problem is obtained by
multiplying the CB column times the RHS column and adding the products.
The result is found in the far right column (RHS) in the Zj row, which here is
b) The current solution does not always equal zero, although it does in this
case because CB = 0.
e. The following is the graphical solution to the foregoing problem:


1 2



1) Given the objective function (OF) 5X + 7Y, the extreme points of the feasible
region yield the following values:
At point OF
(0, 0) 0
(0, 25) (0 × 5) + (25 × 7) = 175
(30, 0) (30 × 5) + (0 × 7) = 150
(10, 20) (10 × 5) + (20 × 7) = 190
f. Computer software packages have been developed to manipulate linear programming
problems with numerous constraints. Recognizing the basic method and its
implications is usually sufficient for the management accountant.
6. Transportation Model
a. The transportation model is a special type of LP problem. It involves physical
movement (transportation) of goods from sources of supply (such as factories) to
destinations (warehouses).
1) EXAMPLE: A fleet of trucks may be available for daily deliveries in a city. Each
day the transportation manager must determine the best route for each truck.
Many possible combinations of trucks and destinations satisfy the constraints of
meeting all deliveries with the available trucks, but the manager would like to
have the minimum cost combination. In effect, the manager must allocate the
available trucks (scarce resources) to the required destinations in a way that
minimizes costs.
b. The objective function includes the transportation cost of each item from each source
to each destination.
1) The constraints are the output for each supply point and the demand by each
2) EXAMPLE: A manufacturer has four plants. Assume that each plant could ship
products to any of 20 warehouses. Each plant has a maximum capacity, and
each warehouse has a minimum demand. Management would like to know
how much should be shipped from each plant to each warehouse in order to
minimize transportation cost.

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8 SU 7: Linear Programming

3) To formulate a general linear programming model, the amount to be shipped

from each plant to each warehouse would have to be stated as a separate
variable. The result would be 80 variables (4 plants × 20 warehouses). Each
plant’s capacity and each warehouse’s demand would be a constraint, giving
24 constraints (4 plant constraints + 20 warehouse constraints).
c. The assignment method is a special case of the transportation method. It is used to
assign employees to jobs, jobs to machines, sales associates to territories, bidders to
contracts, etc.
1) The difference from the transportation method is that each agent (employee,
machine, etc.) can be assigned to only one task.
2) The purpose of the assignment is to optimize a given objective, such as
minimizing cost, minimizing time, or maximizing profits.
3) The assignment model can be modified to accommodate certain variations.
They include the following:
a) Tasks exceed the available number of agents.
b) Certain assignments are unacceptable.
c) More than one agent may be required for some tasks.
d. Vogel’s Approximation, or the penalty method, solves transportation problems
easily. The name comes from the extra amount that must be paid (the penalty) if the
lowest cost alternative is not selected in each row and each column.
1) EXAMPLE: Assume that a company has two factories that produce 18 and
14 units of product, respectively, during a period of time. Three distribution
warehouses demand 15, 10, and 7 units, respectively, during the same period.
The table below depicts this information along with the shipping costs per unit
(e.g., $4 to ship one unit from factory 1 to warehouse C). The objective is to
minimize total shipping costs. The penalties (in dollars) are shown in
parentheses to the right of, and below, the table.



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a) For row 1: If the lowest cost alternative is not used ($4 for C), the
shipment must go to B, whose cost of shipping is $1 higher than shipping
to C. The firm would suffer a $1 penalty for not selecting the lowest cost
box. For column A, the penalty would be $3 ($8 – $5) if the lowest cost
box is not used.

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SU 7: Linear Programming 9

b) The objective under the penalty method is to avoid the highest penalties;
those columns or rows where the highest penalties might occur are filled
first. Because columns A and C have the highest penalties, one of these
(it does not matter which) should be filled first. Choose column C. The
lowest cost box in the selected column should be filled with the maximum
possible number of units. The maximum that can be placed into box 1C
is 7 units because warehouse C needs only 7 units; this step eliminates
column C from further consideration. Draw a line through column C and
recompute the penalties for the remaining columns and rows (if
necessary) as shown below.


6$  3

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 . ,

: : : 



 . ,
 . ,

c) Because column A still shares the highest penalty, fill its lowest cost box to
the maximum extent possible; i.e., assign 14 units to box 2A. The row 2
total supply is 14, thus limiting the number of units that can be assigned to
box 2A. This assignment of 14 units equals the row 2 constraint, so row 2
is crossed out (it no longer needs to be considered).
d) The final units are then assigned to row 1, columns A and B, as shown in
the following table.


6$  3

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 . ,

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 . ,
 . ,

e) The total shipping costs based on the assignments can be calculated by

multiplying the number of units shipped times the shipping cost per unit,
as follows:
1($8) + 10($5) + 7($4) + 14($5) = $156

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10 SU 7: Linear Programming

f) The use of the penalty method resulted in the optimal solution in this
example, which is not always the case. The penalty method will
occasionally result in a very good solution, but not the optimum. There is
a quantitative technique to test for the optimality of a solution, but it is
quite complicated and beyond the scope of this discussion.
7. Goal Programming
a. Goal programming was first introduced as a specialized type of linear programming to
solve problems that had no feasible solution under regular linear programming.
b. Goal programming permits an ordinal specification (ranking) and solution to problems
with multiple goals.
1) With its ability to incorporate multiple goals, the method has the potential for
solving problems with both financial and nonfinancial goals.
8. Integer Programming
a. Integer programming (IP) concerns problems in which some variables are not
continuous. Linear programming, on the other hand, assumes that all variables are
continuous and all functions are linear (i.e., graphed with straight lines). Variables
are thus allowed to take fractional values; 9, 9.367, and 10 are all possible values. In
integer programming, fractions are not possible.
1) EXAMPLE: It might be possible for an oil company to build 12 or 13 gas stations
on a stretch of highway, but it is not clear what an optimal solution of 12.72 gas
stations means.
2) Integer programming problems are also known as discrete models because the
variables take on discrete, noncontinuous values.
b. One way to solve IP problems is to solve them as LP problems and round to satisfy
the integrality condition.
1) In the example, we would decide to build 13 gas stations by rounding 12.72 to
2) Rounding raises several problems.
The rounded solution may violate constraints.
The rounded solution may be farther from the optimal solution than some
other integer combination.
c. A certain class of IP problems concerns variables that are constrained to take on
values of 1 or 0. These are yes-and-no or go, no-go decisions. This class of
problems may be solved only with algorithms designed to handle these constraints.
Rounding is never acceptable because the error induced would be too great.
9. Dynamic programming is an approach to solving problems, not a particular algorithm. It
divides a large mathematical model into smaller, more manageable pieces in such a way
that, once the smaller problems have been solved, the result is the optimal solution to the
overall model.
a. This type of model is useful for problems that involve multistage decisions, that is,
decisions affected by previous decisions.
1) Typically, they are applied to much smaller problems than LP, in terms of
number of variables and constraints.
2) Dynamic programming is useful for problems such as
a) Inventory reordering rules
b) Production scheduling in the face of fluctuating demand
c) Spare parts level determination

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SU 7: Linear Programming 11

d) Capital budgeting for new ventures

e) Systematic search for scarce resources
f) Finding the shortest route through a network
b. The key features of dynamic programming problems are
1) The probabilistic (stochastic) nature of the variables. However, deterministic
variations exist.
2) The iterative formulation of the problems. The optimal solution is reached by a
repetitive process.
c. A decision tree with probabilities of occurrence for each branch is a good example of a
multistage decision process that could be evaluated with dynamic programming.

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