FINANCIAL MODELING Vinodh Madhavan, DBA Adjunct ...

Golden Gate University - Finance and Economics Department

FI307: FINANCIAL MODELING

Vinodh Madhavan, D.B.A.

Adjunct Faculty, Finance & Economics Department, Ageno School of Business, Golden Gate

University

Malcolm S.M. Watts III Research Fellow, Technical Securities Analysts Association of San Francisco

(TSAASF)

Email: [email protected]; [email protected]

Phone: 650-534-4798

Important Dates

Week 1: First Day of FI 307 class: Monday 08/30 4PM (Room/Lab: TBA)

Week 15: Final Project: Due on or before Sunday 12/12/10 Midnight (Pacific Time)

Week 16: Final Exam (Take-home, open notes-open book): Due on or before Saturday 12/18/10

Midnight (Pacific Time)

Course Description

This course presents the theory and practice of financial management, emphasizing computer-

based modeling and forecasting. Emphasis is placed on the usage of spreadsheets and other

software products to analyze the impacts of financial decisions related to financial statement

analysis, cash budgeting, cost of capital, capital budgeting, and capital structure choices. The course

covers a variety of techniques, such as sensitivity and scenario analysis, optimization methods,

Monte Carlo simulation, and regression analysis.

Course Objectives

FI 307 is intended to show students how to create and use models for financial and general

business management.

Students completing FI 307 successfully will learn a variety of spreadsheet skills they can use to

create quantitative models for many functional areas of business, particularly financial

management. The skills successful students will learn include (1) basic operations, such as

organizing spreadsheets, entering numbers and text, performing calculations, (2) creating and

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editing charts; (3) using various statistic, financial and other commands; and (4) applying a number

of advanced techniques, such as linking several worksheets, using split screens, custom

formatting, conditional formatting, using logical IF statements, performing sensitivity analysis with

Excel’s scenario manager tool and with one- and two-variable input tables, embedding and linking

Excel objects to Word documents,, using Excel’s Goal Seek tool to determine the value of an input

variable for satisfying corporate goals, using Excel’s Solver tool to optimize decisions, evaluating

the net present value and rate of return of capital investments, determining the number of years for

capital investments to break even, and using various distributions of random numbers to perform

Monte Carlo simulation and risk analysis.

Students completing FI 307 successfully will be able to apply their spreadsheet modeling skills to

various topics in financial management, such as: preparing and analyzing financial statements,

forecasting annual and seasonal revenues, forecasting financial statements, cash budgeting,

calculating the weighted average cost of capital, determining financial and operating leverage,

identifying break-even points, calculating depreciation, performing capital budgeting, and

determining the value of stocks, bonds, and call and put stock options. The same spreadsheet

modeling skills students will learn for financial management are also useful for marketing and

sales, for production and operations management, as well as for other areas of business and

personal management.

Students completing FI 307 successfully will be able to apply spreadsheets as tools for many

practices that are important to general business management, such as: (1) improving

communications (by using spreadsheets to create tables and charts that communicate as well as

calculate); (2) understanding the importance and usefulness of management information

systems for collecting, accessing, and analyzing data; (3) understanding the functional

relationships between different parts of a company (by showing, for example, the logic and linkage

between finance, marketing, production, and inventory management and how each depends on the

others); (4) improving their negotiating skills (by showing how to use statistical techniques

effectively to focus on issues and depersonalize personal biases); (5) analyzing the sensitivity of

changes in competition and economic conditions on a company’s “bottom line” and evaluating the

options that management might pursue to cope with changes; and (6) evaluating the risks

associated with conducting business in the modern world.

This is a hands-on course with extensive use of computers and Excel software.

Prerequisites

Academic Prerequisites: Satisfactory completion of a graduate-level course in financial

management, such as FI 300.

Spreadsheet Knowledge: GGU policy requires that all students admitted to MBA degree programs

possess basic-level skills in spreadsheet analysis – for example, how to enter text and data, how to

enter expressions for the mathematical operations of addition, subtraction, multiplication, and

division, and how to edit and save a spreadsheet.

Software: Microsoft Excel, version 2003 or later.

Required Text

Corporate Financial Analysis with Microsoft Excel, by Francis J. Clauss (McGraw-Hill Professional,

2009)

The text is available at GGU Bookstore. Other possible avenues for procuring the text are eFollet

(GGU Online Bookstore) and Amazon.

ALL STUDENTS ARE EXPECTED TO A HAVE A COPY OF THE TEXT AT ALL CLASS MEETINGS.

Course Structure and Topics

Please note: All students should have read the assigned chapters pertaining to each week before attending the class. The quality of student participation in the class would be considered as a direct reflection of the level of preparedness of the student(s). Week 1: 08/30 to 09/05: Corporate Financial Statements and Their Analysis

Spreadsheet skills: Organizing and creating spreadsheets; entering and formatting data values;

entering expressions for calculating values; linking worksheets; splitting screens to facilitate

working between several worksheets; using logical IF statements; using conditional formatting to

call attention to conditions that need correcting; pasting an Excel document into a Word document.

Financial management skills: Understanding the three key financial statements (i.e., a company’s

income statement, balance sheet, and cash flow statement) and the relationships between the

various items on them; analyzing the year-to-year changes in financial statements and various

financial ratios; performing vertical analysis of financial statements; using financial ratios to

benchmark a company’s performance against competitors; inserting spreadsheet results into

company reports.

Readings: Prescribed Text - Chapters 1 and 2.

Week 2: 09/06 to 09/12: Forecasting Annual Revenues

Spreadsheet skills: Creating, validating, and using linear, quadratic, cubic, and exponential

regression models to fit the trends of historical data; creating various types of charts (e.g., scatter

diagrams, forecast charts, error patterns, and downside risk curves); estimating the accuracy of

forecasts; expressing forecast accuracy in terms of confidence limits and downside risk curves.

Financial management skills: Making forecasts; recognizing the difference between valid and

invalid forecasting models; handling the risks inherent in forecasts; adjusting regression models for

changes in trends.

Readings: Prescribed Text - Chapters 3 and 4.

Week 3: 09/13 to 09/19: Forecasting Financial Statements

Spreadsheet skills: Using forecasts of revenues to forecast financial statements; using Excel’s

Scenario Manager to do sensitivity analysis.

Financial management skills: Forecasting financial statements and determining what happens if

conditions change.

Readings: Prescribed Text – Chapter 5

Week 4: 09/20 to 09/26: Forecasting Seasonal Revenues

Spreadsheet skills: Creating a seasonally-adjusted forecasting model by joining seasonal

adjustments to an annual trend line or a moving average trend line; using error feedback to correct

a model so that the average error is zero; using period values to update annual forecasts and revise

the model.

Financial management skills: Recognize seasonal variations in cash flows and demonstrate their

importance to a firm’s financial, marketing, and operations management.

Readings: Prescribed Text - Chapter 6.

Week 5: 09/27 to 10/03: The Time Value of Money

Spreadsheet skills: Using Excel’s financial functions for calculating the present value of a future

amount, the future value of a present amount, the net present value of a series of cash flows,

periodic payments for mortgages and loans, etc.; linking an Excel worksheet to a Word document.

Financial management skills: Understand the concept of the time value of money and apply it to

various types of financial decisions (e.g., creating sinking funds).


Week 6: 10/04 to 10/10: Cash Budgeting

Spreadsheet skills: Organizing a spreadsheet into modules for different parts of a company and

linking results; using a one-variable input table for sensitivity analysis to evaluate alternate

operating tactics.

Financial management skills: Understanding the role of a cash budget in a company’s marketing,

production, and financial operations; examining the impacts of changing conditions on cash flows:

forecasting the short-term borrowing and lending a CFO must plan for.


Week 7: 10/11 to 10/17: Cost of Capital

Spreadsheet skills: Calculating the weighted average cost of capital (WACC); using Excel’s Goal

Seek and Solver tools to find the value of an independent variable (e.g., return on equity) to satisfy a

related goal (e.g., a specified WACC); evaluating the WACC for different amounts of capital raised

and creating charts to display the results.

Financial management skills: Identify sources and costs of capital and understand how to use

them to compute a firm’s WACC; distinguish between WACC based on book value and WACC based

on market value; understand what’s meant by flotation costs and how to include them in a firm’s

WACC.


Week 8: 10/18 to 10/24: Profit, Break Even, and Leverage

Spreadsheet skills: Calculating profits from a firm’s cash flows; using Excel’s Solver tool to

determine the sales volume needed to break even; evaluating a firm’s operating, financial, and

combined leverages.

Financial management skills: Be able to explain what’s meant by profit, break-even, and leverage,

how to measure them, and why they’re important.


Week 9: 10/25 to 10/31: Capital Budgeting: The Basics

Spreadsheet skills: Organizing spreadsheets to move from sales revenues to after-tax cash flows;

using Excel’s financial functions to calculate depreciation schedules; calculating financial measures

of success, such as net present value and internal rate of return; using nested IF statements to

determine the discounted years to break even; creating two-variable input tables for sensitivity

analysis; using Excel’s Solver tool to determine changes that must be made to achieve specified

goals, such as a specified net present value or discounted years to break even.

Financial management skills: Review taxes and depreciation; understand the inputs and outputs

of capital budgeting; understand the various types of depreciation; distinguish between income

taxes on regular income and capital gain and how they’re calculated; apply appropriate financial

criteria to evaluate investments in capital assets.

Readings: Prescribed Text - Chapters 11 & 12.

Week 10: 11/1: 11/7: Applications of Capital Budgeting

Spreadsheet skills: Creating spreadsheets that evaluate the financial payments from various types

of capital investments; using one- and two-variable input tables to analyze the sensitivity of

financial payoffs to changes in conditions.

Financial management skills: Evaluate financial payoffs from different types of capital

investments, such as investing in new facilities, investing in non-residential real estate, replacing

equipment; improving production methods, and determining whether to lease or buy equipment.


Week 11: 11/8 to 11/14: Capital Budgeting: Risk Analysis with Scenarios

Spreadsheet skills: Using Excel’s Scenario Manager to analyze the effects of various combinations

of conditions (e.g., best-on-best, most probable, and worst-on-worst) on future payoffs.

Financial management skills: Using probabilities to define risks.


Week 12: 11/15 to 11/21: Capital Budgeting: Risk Analysis with Monte Carlo Simulation

Spreadsheet skills: Using Excel’s tools for Monte Carlo simulation; using Excel’s random number

generator to generate random numbers that follow different probability distributions (e.g., uniform,

normal, and triangular distributions) and use the results.

Financial management skills: Be able to explain the concept of probabilities and their use to

define risks; be able to create downside risk charts and explain their use to show the probabilities

for reaching specified financial goals.


Week 13: 11/22 to 11/28: Common Stock Portfolios

Spreadsheet skills: Evaluate the risks and returns of stock portfolios; use scenario analysis and

two-way input tables to analyze the sensitivity to different conditions; apply Excel's tools for

scenario analysis, variable input tables, and optimization to stock portfolios.

Financial management skills: Recognize the risks and returns of stocks and their tradeoffs;

understand the concepts of efficient market theory and efficient portfolios; interpret and use beta

values; identify and apply diversification strategies for minimizing risk.

Readings: Reading material pertaining to this week would be provided to all students by the

instructor, two weeks prior to the class.

Week 14: 11/29 to 12/5: Call and Put Stock Options

Spreadsheet skills: Creating spreadsheets for displaying the results from buying and selling call

and put options on common stock; calculating the price of an option; evaluating the sensitivity of

the price of an option to underlying factors.

Financial management skills: Understand the concepts of options and derivative securities;

distinguish between call and put options; recognize the advantages and disadvantages of buying

and selling options; understand the role of options for managing risks.



Week 15: 12/06 to 12/12: Valuation of Bonds

Spreadsheet skills: Determining the value of bonds from their fixed future cash flows and an

investor’s expected rate of return; performing sensitivity and risk analysis related to the value of

bonds; evaluate the effect of call date on a bond’s value.

Financial management skills: Be able to define value, as related to bonds, and explain the methods

used to calculate it.



Week 16: Research Project is due on 12/12/10. Final Exam is due on 12/18/10.

Exams, Grading, & Laptop/PC Policies

Your letter grades for the course will be based on a) your level of participation in the class b) your

submittals of 15 homework assignments, c) your research project, and d) your responses to the

final exam. The final exam is an open-book, open-notes take-home exam.

The following points will be multiplied by your percentage grades on the items and added to arrive

at your total points for the course:

Category Points

Level of Participation in class 5

Assignments (15 *4 points) 60

Research Project 20

Final Exam 15

Total 100

Letter grades will be determined from the total points as follows: 98 to 100 is A+, 93 to 98 is A, 91

to 93 is A-, 88 to 91 is B+, 83 to 88 is B, 81 to 83 is B-, 78 to 81 is C+, etc.

Grades will be based solely on your performance on the five graded elements; there will be no

opportunity for extra-credit work. This is a graduate course, which means that you are expected to

perform at an A or B level. But this does not necessarily mean that all students will receive at least

a B. A student may receive less than a B if he/she deserve less than a B. Students should consult the

current GGU Bulletin for University policies regarding incompletes and withdrawals.

Assignments

There are 15 homework assignments, spaced at 1-week intervals. Assignments pertaining to a

session are due on the eighth calendar (not business) day following the date of a session -- that is,

on the Monday of the week following the Monday on which a session takes place. Feel free to

submit assignments before their due dates.

Late submittals will be penalized. Grades will be reduced by 10% for each day assignments are late

(e.g., a grade of 90% will be reduced to 70% if the homework assignment is submitted on the

second day after its due date), and assignments submitted more than one week after their due dates

will be graded zero. On a one-time basis and provided that you advise me a few days before an

assignment is due that your submittal will be delayed, I will allow you an extra week to submit the

assignment without penalty. Except for this one-time allowance for a delay, I expect you to manage

your time so that you can complete all work on schedule and cope with any unexpected

interruptions in your life. So plan ahead and don't delay work until the last minute.

Attach your solution as a single Excel file in an email addressed to [email protected]

Include your name, session number, and a short message on each email.

You are free to work ahead, BUT DON’T FALL BEHIND. Note that in addition to homework, there is

a research project and a final exam that are due by the end of the semester.

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Just exactly what is a good spreadsheet model? To some extent, any model is an idealization of the

real world. Two very important considerations in developing models are (1) to identify the details

of the real world that the model must include in order to make the model useful, and (2) to

recognize what details can safely be omitted without making the model useless. Model making often

starts with simplifying assumptions. Once a model-maker has created a model that works for the

simplifying assumptions, he or she replaces the assumptions one-by-one to refine the model and

make it more realistic.

How much refinement is necessary to make a model realistic enough to be useful? That usually

depends on the model’s purpose. It depends on how financial managers use the types of models we

create in FI307. You need to understand that. You need to understand the limits beyond which your

models should not be used as well as the range of conditions over which they are useful.

Final Exam

The final exam will constitute one or two problems and a few case studies. This can be completed at

home. You are free to use the text, your notes, and any work you have done during the course. You

are on your honor to do this work by yourself, without help from anyone else. I will provide

students with a copy of the final exam in the latter part of October, and students will have

until Sunday, December 12, 2010 (midnight, Pacific Time) to send me their responses in an email to

[email protected]. Please warn me ahead of time if your work or personal affairs will

interfere with meeting this schedule so that we can arrange for a late submittal. Late submittals

with no prior permission from the instructor will affect your final exam grade and may delay the

submittal of your course grade to the Registrar.

Laptop/PC Policy

Laptops and PCs should be used in class only for class activities such as and limited to working on

excel-based problems/cases and for taking notes. They should not be used to check email, surf the

web, or to do other non-class activities such as but not limited to checking face book or LinkedIn.

Academic Integrity

GGU's Policy on Student Academic Integrity is in effect at all GGU teaching locations, including

regional classroom sites, corporate sites, and distance courses delivered in any medium. This policy

applies to all business, taxation, and technology students at Golden Gate University.

Academic integrity means doing academic work in a manner that strives to achieve the learning

objectives your courses have set out for you. It means that you follow the rules and procedures

prescribed by your instructors so that you acquire the skills and knowledge your courses are

designed to give you. It means that you engage in ethical practices in undertaking

assignments, exams, and doing projects and that you respect intellectual property rights by

fully disclosing sources of information that appear in your papers and presentations.

GGU provides many resources and services that assist you in learning the required research and

documentation skills. Please click on the following link to read GGU’s Policy on Student Academic

Integrity:

http://www.ggu.edu/student_services/student_life/griffin_student_handbook/policy_academic_ho

nesty

I hereby cite something that I find to be very comprehensive yet succinct description of what is

expected from students in terms of academic integrity. It is very important that you take note of the

following at all times in your life, especially when you contribute to this course in different ways

ranging from class discussions to final project and final exam.

“All work submitted by students in this class (including but not limited to comments,

postings, charts, examples, problem set solutions, and exam answers) must either be the

product of the student’s own words, understanding or work, or must have credit attributable

to the original source. Students may post content from another source verbatim so long as

the original source is given credit. It is generally suggested that a higher learning outcome is

achieved by a student who has to synthesize information from different sources and express

an understanding in his or her own words. The process of synthesizing and paraphrasing

also allows the student the step of self assessing their real understanding of what they have

just read” (Source: Mary Canning, Dean, School of Taxation and Dean, School of Accounting)

If you copy, cheat in this course, or assist a classmate in cheating, and I become aware of it, you will

not only earn ZERO points for the concerned deliverable(s), but I will also bring it to the notice of

Finance Department Co-Chairs and appropriate members in Golden Gate University

Administration.

Special Needs

Golden Gate University affirms its commitment to its applicants and students who identify and

express their special needs. Information regarding The Americans with Disabilities Acts and GGU’s

policies and services can be found at: http://www.ggu.edu/student_services/disability_services

Instructor Bio

Vinodh Madhavan, D.B.A.

Vinodh Madhavan currently serves as an Adjunct Faculty at Golden Gate University. In addition, he

holds the “Malcolm S.M. Watts III Research Fellowship” position at Technical Securities Analysts

Association of San Francisco. He is currently working on a paper aimed at interpreting non-linear

behavior of his dissertation data sets, by employing methodologies found in the field of chaos

theory. Recently, Vinodh, along with Dr. Henry Pruden (President, TSAASF & Russell T. Sharpe

http://www.ggu.edu/student_services/student_life/griffin_student_handbook/policy_academic_honesty

http://www.ggu.edu/student_services/student_life/griffin_student_handbook/policy_academic_honesty

http://www.ggu.edu/student_services/disability_services

Professor of Business, Golden Gate University, San Francisco) coauthored a paper aimed at

interpreting non-normal behavior of Vinodh’s dissertation datasets, by using concepts and

methodologies found in the book “The (Mis) Behavior of Markets” by Benoit Mandelbrot & Richard

L. Hudson. This paper titled “Implications for Risk Management and Regulation: A study of Long-

term Dependence in Credit Default Swap (CDS) Indices Market” has been accepted for publication

in the forthcoming issue of International Federation of Technical Analysts (IFTA) Journal.

Vinodh has been invited to present his job market paper (based on his dissertation) titled “How

inter-related is American and European Credit Default Swap Indices market? : A search for

transatlantic kinship” at St. John’s University Financial Services Institute’s forthcoming financial

symposium titled “FINANCIAL SERVICES REGULATION: IMPACT ON ACCOUNTING, MANAGEMENT,

AND MARKETING”. The paper was approved in a blind review process by three referees. The same

paper is under consideration for publication in the “Review of Business”- a peer-reviewed journal

published three times a year by Tobin College of Business, St. John’s University, NYC.

Vinodh’s research interests include exploring non-linear time series analysis, long-term

dependence, credit default swap (CDS) indices, and financial contagions. He recently completed his

Doctor of Business Administration program at GGU. Based on faculty recommendations, he was

awarded the “2009-2010 Outstanding Graduate Student – Doctor of Business Administration”

Award by the Dean of Ageno School of Business.

Prior to pursuing his doctoral degree at GGU, Vinodh served in a managerial position for 2 years at

Godrej & Boyce Mfg. Co. Ltd – Appliances Division, India, where he was responsible for after-sales

service delivery mechanism and day-to-day supply chain management. He also holds a Bachelors

degree in Electrical and Electronics Engineering and an MBA in Manufacturing and Operations

Management.

FINANCIAL MODELING Vinodh Madhavan, DBA Adjunct ...

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