Financial Modeling

In Excel

Prof. Robert Irons

Dominican University

Excel for Financial Management i © Robert Irons

 Table of Contents

Subject Pages
How to Use this Book iii
Understanding the Models iv
Interest Factor Calculations 1, 2
Annuity Interest Factor Calculations 3, 4
Other Time Value of Money Calculations 5 -- 8
Bond Valuation Calculations 9, 10
Stock Valuation Calculations 11, 12
Capital Budgeting Calculations 13, 14
Pro Forma Income Statement Calculations 15, 16
Pro Forma Balance Sheet Calculations 17, 18
Excel Tips 19 – 20
Anchoring Cell References 19
Valuation Functions (NPV, MIRR, IRR) 19
Conditional Functions (AND and IF, Conditional Formatting) 19, 20
Dynamic Labels 20
Data Validation 20

Excel for Financial Management ii © Robert Irons

 How To Use This Book

This book is designed to help you understand how to program simple and some slightly
more advanced functions in Microsoft Excel. You do not need to have any computer
programming skills to follow this book, nor will this book offer you any of those skills.
Instead you will learn how to make good use of Excel’s calculation abilities in performing
financial analysis. If you enter the formulas exactly as written in the text, your
spreadsheets will perform as needed, and you will have an exceptional toolkit for
valuing virtually any asset.

In the spreadsheets, the cells highlighted in yellow are those in which the user of the
spreadsheet is to enter data – these are the cells for which the values will change with
each new problem. The cells highlighted in green are to be populated with the financial
data from the firm’s most recent financial statements. The other cells should never
change, or else the functions will not work as intended. The first page of each
section (marked “Template”) shows how the spreadsheet is intended to look. The
second page of each section (marked “Formulas”) shows exactly how you are to enter
the formulas into the cells.

Notice that the row and column references are included in the screen shots of the
models – this gives you exact reference points for the formulas you need to enter.
Simply make sure you enter each item exactly as referenced in the exact cells
indicated, and your models will perform as intended.

One item that is not indicated in the examples is the need to format your data properly.
Percentages need to be formatted as percentages, and dollar amounts need to be
formatted as dollar amounts. This requires the Format Cell command, which can be
obtained by right clicking the mouse when in the cell you wish to format. You will notice
that the Template models show the data formatted properly, but the Formula models do
not – that is because the Formula models show exactly how the data was entered into
the cells. Formatting is done to change the way the data in the cell is presented, and
therefore requires an extra step on your part.

The next section explains how the models are constructed in order to follow the theory
of financial management, so that you can tie the models directly to the examples in your
textbook. Recreating the textbook examples is proof of the models’ accuracy, giving you
confidence that you built them correctly. The section at the end of the book gives
explanations of some of the techniques used in the examples, while also offering tips on
how to enhance your spreadsheets’ functionality and make them appear more
professional.

Spreadsheet skills are highly coveted by employers, and the ability to make clear,
professional spreadsheets will set you apart from other candidates. Use this book as a
starting point and continue to build your spreadsheet skills within your academic career,
and you will open doors to professional opportunities that might otherwise have
remained closed.

Excel for Financial Management iii © Robert Irons

 Understanding the Models

Interest Factor Calculation Models

These models are used to calculate the future value interest factor (FVIF) and present
value interest factor (PVIF), which are the multipliers used to calculate the future or
present value of a single cash flow at a given rate for a given amount of time. You enter
the following data into the model:
 the amount of the cash flow;
 the appropriate interest rate (the annual percentage rate for the future value or
the annual discount rate for the present value);
 the number of years in the future required for the calculation (how many years of
compounding for the future value, or how many years of discounting for the
present value), and
 the number of compounding periods per year.
The model uses the number of years into the future and the number of compounding
periods per year to calculate the periodic rate (i) and the number of periods (n) for the
calculation. It then uses these two data to calculate either the FVIF [(1+i) n] or the PVIF
[1/(1+i)n]. Finally, the cash flow is multiplied by the FVIF to obtain the future value of the
cash flow, or by the PVIF to obtain the present value of the cash flow.

Annuity Interest Factor Calculation Models

These models are used to calculate the future value interest factor of an annuity
(FVIFA) and present value interest factor of an annuity (PVIFA), which are the
multipliers used to calculate the future or present value of a series of identical cash
flows made at regular intervals for a predetermined period of time at a given rate. You
enter the following data into the model:
 the amount of the annuity payment;
 the appropriate interest rate;
 the number of years in the future required for the calculation (how many years of
compounding for the future value, or how many years of discounting for the
present value), and
 the number of compounding periods per year.
The model uses the number of years into the future and the number of compounding
periods per year to calculate the periodic rate (i) and the number of periods (n) for the
calculation. It then uses these two data to calculate either the FVIFA or the PVIFA. The
annuity payment is multiplied by the FVIFA to obtain the future value of the ordinary
annuity, or by the PVIFA to obtain the present value of the ordinary annuity. The
ordinary annuity value is then multiplied by (1+i) to obtain the value of the annuity due
(regardless of whether it is the future value or present value being calculated).

Other Time Value of Money Calculation Models

Bond Valuation Models

Excel for Financial Management iv © Robert Irons

Stock Valuation Models

Capital Budgeting Models

Pro Forma Income Statement Model

Pro Forma Balance Sheet Model

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 Interest Factor Calculations – Template

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 Interest Factor Calculations – Formulas

Excel for Financial Management 2 © Robert Irons

 Annuity Interest Factor Calculations – Template

Excel for Financial Management 3 © Robert Irons

 Annuity Interest Factor Calculations – Formulas

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 Other Time Value of Money Calculations 1 – Template

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 Other Time Value of Money Calculations 1 – Formulas

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 Other Time Value of Money Calculations 2 – Template

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 Other Time Value of Money Calculations 2 – Formulas

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 Bond Valuation Calculations – Template

Excel for Financial Management 9 © Robert Irons

 Bond Valuation Calculations – Formulas

Excel for Financial Management 10 © Robert Irons

 Stock Valuation Calculations – Template

Excel for Financial Management 11 © Robert Irons

 Stock Valuation Calculations – Formulas

Notice that this does not show the entire spreadsheet – follow the call-out boxes above and enter the formulas as
shown, then copy them to the cells to the right using your mouse’s drag & fill feature.

Excel for Financial Management 12 © Robert Irons

 Capital Budgeting Calculations – Template

Excel for Financial Management 13 © Robert Irons

 Capital Budgeting Calculations – Formulas

Notice that this does not show the entire spreadsheet – follow the call-out boxes above and enter the formulas as
shown, then copy them to the cells to the right using your mouse’s drag & fill feature.

Excel for Financial Management 14 © Robert Irons

 Pro Forma Income Statement Calculations – Template

Excel for Financial Management 15 © Robert Irons

 Pro Forma Income Statement Calculations– Formulas

Excel for Financial Management 16 © Robert Irons

 Pro Forma Balance Sheet Calculations – Template

Excel for Financial Management 17 © Robert Irons

 Pro Forma Balance Sheet Calculations – Formulas

Notice that cells C3, C4, C5 & C6 pull data from the Pro Forma Income Statement model given on page 15. Also
notice that the Retained Earnings calculation in cell E27 adds in the Retained Earnings listed above in cell C6.
These two models are linked and therefore intended to be used together to analyze a single firm.

Excel for Financial Management 18 © Robert Irons

 Excel Tips and Advanced Techniques

Anchoring Cell References

When using Excel’s drag & fill functionality to copy a formula to a series of connected
cells, if any of the cells referenced in the formula are absolute (i.e., they do not change
location), then they must be anchored in the formula. For example, in the Discounted
Payback Period calculations done in the model on page 13, the discount rate used in
the formulas is located in cell B15. If you enter the formula in cell B21 by referencing the
discount rate in cell B15 (which is the proper way to create a model), you must anchor
that cell reference. That way when you drag the formula across to cells C21 – L21, the
reference to the discount rate in cell B15 does not change.

The way to anchor the cell reference is to hit the F4 key right after highlighting the cell
reference to be anchored. When you do that, the cell reference will change from “B15”
to “$B$15”. The dollar signs anchor the cell reference so that it does not change when
dragging the formula to other cells.

Valuation Functions

NPV Function: Excel's NPV function is actually a present value (rather than a net
present value) function because it discounts all selected cash flows to the period prior to
the first cash flow. Therefore it is necessary to add the initial cash outflow to the function
to arrive at the net present value. The function is structured as follows: =NPV(discount
rate, cash flows). The first item in the parentheses is the discount rate used to arrive at
the present value. The second item is the array of cash flows starting in period one. To
include the initial cash outflow (which should be a negative number), construct the
formula as follows: =NPV(discount rate, cash flows) + Initial Cash Outflow.

IRR Function: Inputs to the IRR function are the array of cash flows (note that this
function includes the time zero cash flow) as well as a guess at the internal rate of
return. Any value greater than zero and less than one will do for the guess – it would be
simplest to use the discount rate. The function should be entered as follows: =IRR(cash
flows, IRR guess).

MIRR Function: Excel's MIRR function requires three inputs: the array of cash flows
(this function also includes the time zero cash flow), the discount rate used for
calculating the present value, and the reinvestment rate used for calculating the horizon
value. Again it would be simplest to use the discount rate for both of these rates. The
function should be entered as follows: =MIRR(cash flows, discount rate, reinvestment
rate).

Conditional Functions

AND and IF Functions: The IF function can be used to set a criterion for the formula
entered in the cell. The function is structured as follows: =IF(test criterion, value if true,

Excel for Financial Management 19 © Robert Irons

value if false). The value displayed in the cell will depend upon the results of the logical
test applied. Thus, if the statement reads: =IF(A1<=0,"Bad","Good"), then the statement
will look in cell A1, read the value entered there, and return the word "Bad" if the value
is zero or less, or "Good" if the value is greater than zero. If two criteria are needed, you
can use a nested IF and AND statement: =IF(AND(criterion 1, criterion 2), value if true,
value if false). This statement only applies the "value if true" if both criteria are met. For
example, when calculating the Payback Period and Discounted Payback Period, employ
the following statement: =IF(AND(current year's cumulative cash flow > 0, prior year's
cumulative cash flow <= 0), number of prior year + current year's cumulative cash flow ÷
current year's total cash flow,""). The two quotes at the end of the statement instruct the
function to leave the cell blank if either or both criteria are false.

Conditional Formatting: In the Format pull-down menu there is a selection called

Conditional Formatting. This function can be used to highlight the value in a cell if it
meets certain criteria. For example, the cell font can be set to print in red if the value in
a cell is negative. This can be useful for highlighting negative NPV values in a project
analysis, for example. Similarly, it can be used to print the IRR and MIRR in red if they
are less than the WACC (the discount rate), or print the Payback Period and Discounted
Payback Period in red if they are greater than the depreciable life of the project.

Dynamic Labels

Excel allows numerical values to be displayed as text, and for the text versions of these
values to update as their reference cell updates. For example, consider the following
entry: ="FV of CF in "&TEXT(B9,"0")&" periods at "&TEXT(B8,"0.0000%")&" interest per
period", which could be used in cell A26 of the formulas for the first model (see page 2).
The formula first enters the text written between the quotes, then adds a dynamic label
for the numerical value in cell B9. In this case the numerical value is formatted as a
percentage with four decimal places (the purpose of the entry between the second set
of quotes). The label updates every time the value in cell B9 updates. The same thing
occurs with regard to the second part of the formula, but uses the data in cell B8.

Data Validation

Excel's Data validation function limits the values a specific cell can take. For example, it
is well-known that the growth rate in a dividend discount model must be less than the
discount rate when calculating the present value of a stock using the Gordon model. To
ensure another user of the spreadsheet does not enter a growth rate greater than the
discount rate, you can "lock" the cell against receiving erroneous entries. To accomplish
this, pull down the Data menu and select Validation. The Data Validation box opens,
allowing for the selection of three criteria: the format of the data (text vs. numeric, whole
number or decimal, etc.), the comparison function (equal to, less than, greater than or
equal to, etc.), and the point of comparison (a number or the value in another cell).
Excel also provides the option of including a text box that will automatically display
when the cell is selected so you the nature of the restriction placed on the cell can be
explained. An error message box can also be included if an erroneous entry is made.

Excel for Financial Management 20 © Robert Irons