LINEAR PROGRAMMING PROBLEM

FINANCIAL PLANNING
First American Bank issues five types of loans. In addition, to diversify its portfolio, and to minimize risk, the bank invests in risk-free securities. The loans and the risk-free securities with their annual rate of return are given below. Rates of Return for Financial Planning Problem Type of Loan or Security Annual Rate of Return (%) Home mortgage (first) 6 Home mortgage (second) 8 Commercial loan 11 Automobile loan 9 Home improvement loan 10 Risk-free securities 4

FINANCIAL PLANNING (CONTINUDED)

The banks objective is to maximize the annual rate of return on investments subject to the following policies, restrictions, and regulations: 1. 2. 3. 4. 5. The bank has $90 million in available funds. Risk-free securities must contain at least 10 percent of the total funds available for investments. Home improvement loans cannot exceed $8,000,000. The investment in mortgage loans must be at least 60 percent of all the funds invested in loans. The` investment in first mortgage loans must be at least twice as much as the investment in second mortgage loans. 6. Home improvement loans cannot exceed 40 percent of the funds invested in first mortgage loans. 7. Automobile loans and home improvement loans together may not exceed the commercial loans. 8. Commercial loans cannot exceed 50 percent of the total funds invested in mortgage loans.

SOLUTION

SUBJECT TO THE FOLLOWING CONSTRAINTS1) x1 + x2 + x3 + x4 + x5 + x6 = 90,000,000 (budget constraint) 2) x6 >= 9,000,000 (risk free securities constraint) 3) x5 <= 8,000,000 (home improvement loans constraint) 4) 0.40x1 + 0.40x2 - 0.60x3 - 0.60x4 - 0.60x5 >= 0 (mortgage constraint) 5) x1 - 2x2 >= 0 ( 1st and 2nd mortgage loan constraint) 6) x5 0.40x1 <= 0 (home improvement loans and 1st mortgage loans constraint) 7) x4 + x5 x3 <= 0 (automobile loans, home improvement loans and all commercial loans 8) x3 - 0.50x1 - 0.50x2 <= 0 (commercial loans and mortgage loans) 9) x1 , x2 , x3 , x4 , x5 , x6 >= 0 (non-negativity constraint)

INTERPRETATION
x1 = 32,400,000 (dollars invested in the 1st home mortgage loans)

x2 = 16,200,000 (dollars invested in the 2nd home mortgage loans)

x3 = 24,300,000 (dollars invested in commercial loans) x4 = 1,000,000 (dollars invested in automobile loans)

x5 = 8,000,000 (dollars invested in home improvement loans)

x6 = 9,000,000 (dollars invested in risk free securities) Z = $7,082,000 (profit over the investment of $90,000,000)

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