1. Steps for verifying your homeworks and lab exam models With homeworks you can compare results to fellows students –Do not try this during a lab exam –Consequences if caught are not believable! When you are on the job not possible to check results against other models So here are things I recommend Lab Exam Prep

2. Start with a plan –Sketch out on paper a list of calculations to follow from the start to the KOV Next develop stochastic variables 1.Summary stats 2.Test for presence of a trend 3.Use UPES to determine best distribution if you are on the job … in lab exam you will not have time for UPES 4.Estimate parameters as MVEMP as fraction of mean or trend 5.Simulate random variables 6.Validate for Means and Correlation Develop the Model in Steps

3. 1.Start with variables which are inflated by PPI, CPI or other inflation indices –Fixed costs –Family withdrawals –Fixed costs for enterprises –Variable production costs per unit of output –Asset values 2.Calculate local interest rates 3.Calculate local price wedges 4.Transpose stochastic variables matrix 5.Localize prices Preparation Steps to Simulate Equations in the Model

4. 1.For each enterprise (crops on a farm) –Production –Local prices –Receipts –Variable and fixed costs 2.Specific equations for the scenarios –Insurance –Government payments –Futures and options 3.Programs the scenarios into the model Program All Remaining Equations

5. Income statement –List each source of receipts separately so you make sure they are all included (i.e., do not have total crop receipts) –List all sources of cash expenses separately –List all interest expenses separately –Operating interest calculated using the sum of NON-INTEREST cash expenses –INCLUDE interest for cash flow deficits Financial Statements

6. Cashflow statement –Beginning cash Jan 1 EQUALS Cash Dec 31 from the BALANCE SHEET –Calculate interest earned based on cash Jan 1 –Cash outflows include: cash withdrawals, principal payments, income taxes, down payments, Cashflow Deficit from Balance Sheet –Ending cash is the Ending Cash on Dec 31 and MUST NOT be used as beginning cash Jan 1 It must go to the Balance Sheet as an asset before it can become beginning cash Jan1 next year Financial Statements

7. Balance Sheet –List assets from most liquid to least liquid –MUST have an =IF(ending cash > 0) statement in the cash line Must pass cash in “year t” to the Cashflow Statement for “year t+1” –Must have an =IF(ending cash < 0) in the liabilities to account for cash flow deficit loans Must pass deficits in “year t” to Income Statement and to Cashflow Statement for “year t+1” Financial Statements

8. To test if the Income, Cashflow and Balance Sheet Statements are linked do the following –Type a BIG Negative value for Ending cash in the Cashflow for year 2 or 3 –Check that the cash Jan 1 is zero –Check if a deficit appears in the Balance Sheet –Check that the deficit is paid the next year –Check that interest is paid in the next year After you are certain the equations are working press Control Z to replace the number with the real equation Verification Tips

9. Test second, third, etc. Scenarios –Replace the =SCENARIO() function temporarily with the values for the second scenario Verify that the equations throughout the model work for the second scenario –Repeat this verification test for each scenario Verify that the equations throughout the model work for each of the scenarios –When you are satisfied that the scenarios work properly, replace the typed in values with =SCENARIO() for every variable Verification Tips

10. Validation tests for means fail –Is it because you used forecasted means different from history? If so use Test Parameters to test the simulated data against the forecasted means, one at a time –If you used historical means for the forecast Check your equations for the stochastic variables using the Trace Dependence to be sure the equations really used the correct means Can also check which means were actually used in the stochastic equations by pressing F2 Verification Tips

11. Validation tests for Correlation failed –First make sure you are testing simulated variables against the correct correlation matrix –If used deviations about mean you can test against the correlation matrix for the historical data –If you used deviations about trend or structural models you MUST test against the correlation matrix of residuals from the regression models –Use the trace precedence and F2 to make sure your stochastic equations used the correct input data Verification Tips

12. NPV looks bad –Check beginning net worth to be sure it includes all beginning debts –Check if the land and machinery are inflated/deflated correctly –Check it net worth is calculated correctly –Check if the discount rate factors are correct –Check if you really used Net Worth for the last year simulated –Check if the formula is correct NPV = - BNW +∑ (Withdrawals t / (1+i) t ) + PVENW Verification Tips

13. Income taxes are suspiciously large or small –Be sure the income line includes Net Cash Income plus interest earned –Be sure depreciation and other tax deductible expenses are constant (in our problems) –Be sure you linked the variables to your financial statements correctly –Check if you linked the income taxes to the Cashflow Statement correctly Verification Tips

14. Ranking risky alternatives –SDRF only uses negative exponential utility function –SERF defaults to negative exponential utility function Upper RAC = 4 / beginning net worth If you use this Upper RAC your ranking with a Neg Expo Utility function will be the same as the Power Utility function –StopLight targets should be set so at least one scenario has 25% green and 25% red Look at the 125 th and 375 th values if you simulated 500 iterations for starting values as targets Verification Tips

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