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MIT ESD 70J - Excel Session 1

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ESD.70J Engineering Economy ModuleAbout this classMore about this classIntroduction of CourseOur ability to forecastModeling with dynamic mentalitySlide 7Why Excel?Why not ExcelClass outline - Four CornerstonesTeaching methodsSession one – NPV and Sensitivity AnalysisProper Set-up of spreadsheetNPV primer (Net Present Value)What is the appropriate Discount Rate ‘r’?Set up NPV base caseBig vs. Small?Worksheet for Plan AWorksheet for Plan BFew Excel TricksSlide 21Check the solution sheet. Any questions?Sensitivity AnalysisTools for Sensitivity AnalysisData TablesOne-way Data TablesOne-way Data Table (Cont)More Excel tricksOne-way Data Table ExampleOne-way Data Table Example (Cont)Is it working for you?Modifying Data TablesTwo-way Data TablesSlide 34Two-way Data Table ExampleTwo-way Data Table Example (Cont)Slide 37Slide 38Excel ChartsThe Chart WizardChart exampleChart example (Cont)Done?Goal SeekGoal Seek ExampleAdditional note: NPV functionAdditional Note: Text functionText Functions used: ="Discount Factor @ "&TEXT(Entries!C3,"##.0%")Questions? Comments? Suggestions?SummaryWant to learn more Excel ?Next class…ESD.70J Engineering Economy Module - Session 1 1ESD.70J Engineering Economy ModuleFall 2005Session OneAlex Fadeev - [email protected] for this PPT: http://ardent.mit.edu/real_options/ROcse_Excel_latest/ExcelSession1.pdfESD.70J Engineering Economy Module - Session 1 2About this class•ESD.70 – Excel modeling •4 recitation-style sessions•Learn enough Excel to: –Become dangerous–Appreciate the power of Excel–Gain confidence in own Excel modeling prowess –Prepare for ESD.71ESD.70J Engineering Economy Module - Session 1 3More about this class•This class is not meant to be:–Formal•Ask questions at any time •Compare notes with/help each other –Theoretically intensive•I’ll cover a few relevant theories•You are NOT expected to learn them in this class if you do not already know them•Just learn how to use them in Excel–Can take it for credit, or attend to learn/have fun–No tests/exams !ESD.70J Engineering Economy Module - Session 1 4Introduction of Course•Decision-making based on the forecast of the future•Who will usually do better:–Deterministic mentality – improving forecast (and making the best decision based on the probabilities of the expected outcomes) –Dynamic mentality – admitting that the forecast is likely to be wrong (trading-off suboptimal near-term decisions for the flexibility to delay longer-term commitment until the uncertainties resolve or the forecasts improve)ESD.70J Engineering Economy Module - Session 1 5Our ability to forecastHeavier-than-air flying machine are impossible.Lord Kelvin – British Mathematician, Physicist, and President of the British Royal Society, c. 1895They couldn’t hit an elephant at this dis___General John Sedgwick – Union Army Civil War officer’s last words, uttered during the Battle of Spotsylvania, 1864Reagan doesn’t have the presidential look.United Artists Executive – dismissing Ronald Reagan for the starring role in the movie of THE BEST MAN, 1964… weather … oil supply … stock market …ESD.70J Engineering Economy Module - Session 1 6Modeling with dynamic mentality•We cannot ignore the intrinsic uncertainty of the future•Dynamic mentality in decision-making is critical•Excel is a decent tool for decision analysis. It is the focus of this class.•We teach how to unleash the power of Excel to model in a dynamic settingESD.70J Engineering Economy Module - Session 1 7•More about uncertainty and flexibility provided in ESD.71 – Engineering Systems Analysis for Design•ESD.70 provides –necessary knowledge on Excel modeling for ESD.71, and–Introduction of advanced Excel techniques for those interested•May also consider ESD.76/.762 and otherESD.70J Engineering Economy Module - Session 1 8Why Excel?•Seems too simple … •Why not something more exotic, like MatLab, SAS, etc?•Excel is a LOT more POWERFUL than you think•Excel is ubiquitous•Excel forces you to build your models at a granular level – great for learning the nuts and bolts•Knowledge of Excel is assumed in ESD.71 and in many real-world modeling situations •Excel models are fairly easy to explain/understandESD.70J Engineering Economy Module - Session 1 9Why not Excel•Quirky•Rudimentary support •Performance limitations•Data file coupling (unwieldy size)•Certain Functionality constraints–it will take you far, but at some point you may need to get really seriousESD.70J Engineering Economy Module - Session 1 10Class outline - Four Cornerstones•NPV and Sensitivity Analysis - base case and analysis•Monte Carlo Simulation – key technique to model uncertainties•Modeling Uncertainties – the common stochastic movements•Analyzing and Valuing the Flexibility – flexibility changes risk profileESD.70J Engineering Economy Module - Session 1 11Teaching methods•Class as four continuous tutoring sessions –Work through the in-class exercises–Ask away ! A question not asked is a waste of your tuition money –Solutions provided via wireless Web in class (ask for a CD if you can connect)•Exercises built around analyzing the case of “Big vs. Small?”•Laptop with wireless connection is essentialESD.70J Engineering Economy Module - Session 1 12Session one – NPV and Sensitivity Analysis•Objective: –Proper set-up of spreadsheets to facilitate sensitivity analysis–One-way/two-way Data Tables–Goal Seek–ChartsESD.70J Engineering Economy Module - Session 1 13Proper Set-up of spreadsheet•Debugging is inevitable when programming•Sensitivity analysis require changes of inputsGood habits that will make your life easier:•Enter entries into a separate area or a sheet•Set up the calculations by formulas linked to entries => NEVER HARD CODEESD.70J Engineering Economy Module - Session 1 14NPV primer (Net Present Value)•NPV = PV (Cash Inflows) - PV (Cash Outflows)where r reflects the riskiness of the cash flows•NPV > 0 => accept the projectT0=tttr)+(1CF =NPVESD.70J Engineering Economy Module - Session 1 15What is the appropriate Discount Rate ‘r’?•‘r’ reflects the riskiness of the cash flows•Conversion rate across time•Different ways to refer to r–Opportunity cost of capital–Required rate of return–Appropriate discount rate–Hurdle rate–Etc.ESD.70J Engineering Economy Module - Session 1 16Set up NPV base case Now try on your


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