ModelingProcess

StructuredModelingProcess(PowellandBatt,ModelingforInsight,Wiley)
1.
2.
3.
4.

FrametheProblem
DiagramtheProblem
BuildaModel
GenerateInsight

ModelingTools(PowellandBatt,ModelingforInsight,Wiley)
1.
2.

3.

InfluenceDiagrams
SpreadsheetEngineering
a. Design
i. SketchtheSpreadsheet
ii. OrganizetheSpreadsheetintoModules
iii. StartSmall
iv. IsolateInputParameters
v. DesignforUse
vi. KeepItSimple
vii. DesignforCommunication
viii. DocumentImportantDataandFormulas
b. Build
i. FollowaPlan
ii. BuildOneModuleataTime
iii. PredicttheOutcomeofeachFormula
iv. CopyandPasteFormulasCarefully
v. UseRelativeandAbsoluteAddressingtoSimplifyCopying
vi. UsetheFunctionWizardtoEnsureCorrectSyntax
vii. UseRangeNamestoMakeFormulasEasiertoRead
viii. UseDummyInputDatatoMakeErrorsStandOut
c. Test
i. MaintainaSkepticalAttitude
ii. CheckthatNumericalResultsLookPlausible
iii. CheckthatFormulasareCorrect
iv. TestModelPerformance
d. Analyze
i. BaseCaseAnalysis
ii. WhatIfAnalysis
1. DataSensitivity
2. TornadoChart
iii. BreakevenAnalysis
iv. OptimizationAnalysis
v. SimulationAnalysis

Parameterization

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4.
5.
6.

SensitivityAnalysis
StrategyAnalysis
IterativeModeling

WatsonTruckRental
(adaptedfromMoore&Weatherford2001)

Consistingof50largetrucksrentedbyindustrialcontractors,theWatsonTruckRentalCompanyisforsalefor
$1,000,000.EricWatson,theseller,wantsyoutodevelopathreeyeareconomicanalysistoassistpotentialbuyers
inevaluatingthecompany.
Watsonpayspropertytaxesof$35,000peryear,anditcosts$4800pertruckperyeartoadministerandmaintain
thefleet.Thepropertytaxesareexpectedtogrowatarateof4%peryear,andthemaintenancecostsare
expectedtogrowat7%peryear.
Truckrentalrateiscurrently$1000permontheach.Atthisrentalrateonaverage60%ofthetrucksarerented
eachmonth.Watsonbelievesthatifheloweredtherentby$100pertruckpermonth,hewouldincreasethe
averagerentalpercentagebysevenpercentagepointsandthatthisincrementwouldapplytoeachadditional
reductioninrentrateof$100(orfractionthereof).Forexample,ata$600truckrentalrate88%ofthetrucks
wouldberentedeachmonth.Whatevertruckrentalrateissetforthefirstyearwillbeincreasedby9%peryear
foryears2and3.Averagepercentoftrucksrentedinyears2and3willbethesameasdeterminedinthefirst
year,regardlessoftheincreasedrentalrateinthoseyears.
Attheendofthreeyears,Watsonassumesthebuyerwillresellthetruckbusinessforcashataprofit.Theselling
priceatthattimeisassumedtobethreetimestherevenueinyear3.Cashflowineachyearisassumedtobethe
sameasthenetincome(revenueexpenses)forthatyear.Effectsofdepreciationandotherfactorsrelatingto
incometaxescanbeignoredforthisanalysis.
Cashflowinyear3includesinadditionthecashfromtheresaleofthebusiness.Overallinvestmentprofitis
definedtobetheNetPresentValueoftheannualcashflows(discountrate=10%)includingthepurchasepriceat
thebeginningofyear1(assumeotherflowsoccurattheendoftheirrespectiveyears).Assumenotrucksare
boughtorsoldduringthethreeyears.

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DevelopInfluenceChartandPseudocode

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ModelOutline

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InputsandFormulas

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OneWayDataTableAnalysis

NPV vs. Initial Rental Rate

$300,000
$200,000
$100,000

NPV

$0
($100,000)

$0

$200

$400

$600

$800

$1,000 $1,200 $1,400 $1,600

($200,000)
($300,000)
($400,000)
($500,000)
($600,000)
Rental Rate

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OneWayTables(Some,NotAll)forSensitivityChart

CompletedSensitivity(Spider)Chart

Sensitivity Analysis

NPV

$500,000.00
$400,000.00

Purchase Cost

$300,000.00

Maint Cost/Unit

$200,000.00

Property Taxes

$100,000.00

Sales Multiplier

$80%

90%

100%

110%

120%

Percent

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UsingScenarioManager

SupposewewanttoexaminethreescenariosthatweclassifyasBestCase,MostLikelyandWorst
Casefortheinputvariablesshowninthefollowingtable:

WorstCase

MostLikely

BestCase

PurchasePrice

$1,250,000

$1,000,000

$750,000

VarCost/Truck

$4,000

$4,800

$5500

PropTaxGrowth

6%

4%

3%

TruckCostGrowth

10%

7%

5%

RentalRateInflation

7%

9%

12%

BusinessSale
Multiplier

1.5

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continuetheprocessuntilallscenariosaredefined
ThenexamineresultsusingSummary

Choosingoneormoreresultcells:

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PracticeExample
{Moore&Weatherford,DecisionModeling.}

Astartupcompany,SimonPiecompanygeneratesprofitfromcombiningtwopurchasedingredients(
fruitandfrozendough)intoapplepies,processingthepies(cookingpackaging,deliveryetc),andselling
themtoalocalgrocerystore.ThecompanysfounderSamuelSimonintendstobuildanexcelmodelto
explorehisoptions.
SimonsInitialModelInputValues
PiePrice

$8

Piesdemandedandsold

16

Unitpieprocessingcost($perpie)

$2.05

Unitcost,fruitfilling($perpie)

$3.48

Unitcost,dough($perpie)

$0.30

Fixedcost($000sperweek)

$12

BlackBoxView

InfluenceDiagram

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KeyRelationships:

SketchSpreadsheetLayout:

BuildModel:

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Model:

Aftersomereflection,Simonconcludesthatatapiepriceof$12therewouldbenodemandforhispies
andthatbelowa$12pricehewouldgainanadditional4000piessoldperweekforeach$1reductionin
price.So,forsimplicity,heassumesthatademandrelationshipisexpressedbyalinearequation,
producingthefollowingequationforSimonsweeklypiedemandinthousandsofpies:

DevelopSketchandlinearmodel

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Incorporatingthischangeinourmodel:

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Wewanttoexaminetheimpactofpiepriceonprofitusingadatatable.

ExampleContinued

Examiningthemodel,itappearsthatactualweeklypieprofitsaresomewhatlessthanprojected.In
reviewingthemodelsbehaviorforlowerpieprices,SimonsuspectsthatthemodelsProcessingCost
formulaproducesthecorrecthistoricalcostforthebasecaseof12,000PiesDemanded,butnotfor
othervaluesofPiesDemanded.
So,wecollectdataonActualProcessingCostfordifferentlevelsofpieproduction(seebelow).

Developamodelforprocessingcostbasedondatacollected.Revisedyourmodeltoincorporatethis
revisedrelationshipbetweenproductionandprocessingcost.

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RevisingModel

FinalFormulas:

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AnotherDataTableandXYScatter

SensitivityAnalysis
Weexaminetheimpactofinitialparametersvaryingacrossarangeof80%to120%oforiginal
estimatedvalueandobservedtheimpactonProfitthroughacombinationofonewaydatatablesand
XYscatter.

Developaspiderchartofunitcostfruitfilling,unitcostdough,demandintercept,demandslopeand
fixedcost.Commentoninsightsyoucangainfromthischart:

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$0
($200)80%

Profit Sensitivity
90%

100%

110%

120%

($400)
($600)
Unit Cost, Filling

Profit

($800)

Unit cost, Dough

($1,000)

Demand Intercept

($1,200)

Demand Slope

($1,400)

Fixed Cost

($1,600)
($1,800)
($2,000)
% Change in Base Value

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