Table of Contents Chapter 4 (The Art of Modeling with Spreadsheets) The Everglade Golden Years Co. Cash Flow Problem (Section 4.1) 4.2–4.3 The Process of Modeling with Spreadsheets (Section 4.2) 4.3–4.11 Guidelines for Building “Good” Spreadsheet Models (Section 4.3) 4.12–4.16 Debugging a Spreadsheet Model (Section 4.4) 4.16–4.19 McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

The Everglade Cash Flow Problem Year Projected Net Cash Flow (millions of dollars) 2011 –8 2012 –2 2013 –4 2014 3 2015 6 2016 2017 2018 7 2019 2020 10 4-2

The Everglade Cash Flow Problem Their short-term cash flow requirements cannot be met without borrowing. A long-term (10 year) loan can be taken with an interest rate of 7% A series of short-term loans (1 year) can be taken with a projected interest rate of 10% Question: Which loan (or combination of loans) should be taken, and in what amounts, in order to maximize their cash-balance position after 10 years? 4-3

The Process of Modeling Figure 4.1 A flow diagram for the general plan-build-test-analyze process for modeling with spreadsheets. 4-4

Plan: Visualize Where You Want to Finish A common stumbling block in the modeling process occurs right at the beginning—”How do I get started?” At this point it can be useful to ask the question—”Where do I want to end up?” What information do I need to provide in a report? What should the “answer” look like? What kinds of numbers need to be included in the recommendation? What information is needed in the Everglade Cash Flow problem? 4-5

Plan: Do Some Calculations by Hand Another common stumbling block arises when trying to enter a formula in one of the output cells. At this point, it can be useful to do some calculations by hand. Just pick some numbers for the changing cells and determine what the results should be. Suppose Everglade takes out a $6 million long-term loan and then adds short- term loans of $2 million in 2011 and $5 million in 2012. How much cash will they have left at the end of 2011? How much cash will they have left at the end of 2012? 4-6

Plan: Sketch Out a Spreadsheet Figure 4.2 Sketch of the spreadsheet for Everglade’s cash flow problem. 4-7

Build: Start with a Small Version If the model is complicated, start with a small, readily manageable version of the model. First make sure you’ve got the logic of the model worked out correctly for the small version. Only then expand it to full size. Figure 4.3 A small version (years 2011 and 2012 only) of the spreadsheet for the Everglade cash flow management problem. 4-8

Test: Test the Small Version of the Model Test the small model thoroughly. Try values in the changing cells for which you know the answers (at least approximately). Examples: All zeroes All ones Very large numbers Numbers for which you’ve done hand calculations Expand the model to full size (copying formulas to the later years). Test the large model in a similar way. 4-9

Analyze: Analyze the Model (Before Solver) Figure 4.4 A complete spreadsheet model for the Everglade cash flow management problem before calling on the Excel Solver. The entries in the changing cells, LTLoan (D11) and STLoan (E11:E20), are only a trial solution at this stage. 4-10

Analyze: Analyze the Model (After Solver) Figure 4.5 A complete spreadsheet model for the Everglade cash flow management problem after calling on the Excel Solver to obtain the optimal solution shown in the changing cells, LTLoan (D11) and STLoan (E11:E20). The target cell EndBalance (J21) indicates that the resulting cash balance in 2021 will be $2.92 million if all the data cells prove to be accurate. 4-11

Guidelines for Building “Good” Spreadsheet Models Enter the Data First Any spreadsheet model is driven by the data It is easier (and usually better) to build the model around the data Organize and Clearly Identify the Data Relevant data should be grouped (e.g. in tabular form) All data should be labeled Units should be identified Enter Each Piece of Data into One Cell Only Refer to the original data as needed This makes the model much easier to modify (only need to change data in one place) 4-12

Guidelines for Building “Good” Spreadsheet Models Separate Data from Formulas Avoid putting numbers directly in formulas Put numbers in data cells and refer to them as needed This makes all data visible and easier to modify Keep It Simple Avoid “power functions” of Excel if possible Break out complicated formulas into subtotals Use Range Names Refer to data cells and blocks of cells using Excel’s range name feature Range names make formulas and the Solver model much easier to read Care must be taken not to overuse range names and to make sure they remain correctly defined. 4-13

Guidelines for Building “Good” Spreadsheet Models Use Relative and Absolute References to Simplify Copying Formulas Whenever multiple related formulas will be needed, try to enter the formula just once, and then use Excel’s fill commands to replicate the formula. This makes the model easer to build and also reduces typos. Use Borders, Shading, and Colors to Distinguish Cell Types For example: Data cells in blue (no border) Changing cells in yellow (regular border) Target cell in orange (heavy border) Show Entire Model on Spreadsheet All data should be visible. All constraints should be on the spreadsheet (not buried in Solver), preferably in three consecutive cells. 4-14

Three Tests for a “Good” Spreadsheet Model You should be able to immediately identify the data cells, changing cells, and target cell. All elements of the model should be visible on the spreadsheet (including all constraints). You should not have to look in the Solver dialogue box to figure out the model. Each equation should be simple enough that you can tell what the equation is in each output cell without looking. 4-15

A Poor Spreadsheet Model Figure 4.7 A poor formulation of the spreadsheet model for the Everglade cash flow management problem. 4-16

Debugging a Spreadsheet Model: The Toggle Figure 4.8 The spreadsheet obtained by toggling the spreadsheet once to replace the values in the output cells by the formulas entered into those cells. Using the toggle feature in Excel once more will restore the view of the spreadsheet. Pressing control-~ toggles back-and-forth between showing values and showing formulas in the spreadsheet. 4-17

Dependents of the LT Loan Cell Figure 4.10 The spreadsheet obtained by using the Excel auditing tools to trace the dependents of the LT Loan value in cell D11 of the spreadsheet. 4-18

Precedents of the ST Interest (2012) Cell Figure 4.11 The spreadsheet obtained by using the Excel auditing tools to trace the precedents of the ST Interest (2012) calculation in cell G12 of the spreadsheet. 4-19