Chapter 1

Financial Modelling with

Microsoft Excel
Learning Outcomes

The study of this chapter should enable you to:
explain what is finance
relate financing decision to individual and business
discuss the principles of finance
create a financial model
Why study Finance?
Finance is the study of financial
decision making.
Companies and individual make
financial decision every day.
It is important to make a sound financial
decision.
Financial modelling allows to
achieve this.
Financial Decision Making
You need RM1,000 in two years. Your
bank pays 10% interest. How much do
you need to save each year?
You want to buy a house to rent it out.
How should you evaluate this
decision?
How do you measure financial risk?
Financial Decision Making
A company is considering replacing an existing
machine with a newer, faster, and more expensive
machine.
How do we make this decision?
A division of your company wants to develop a
new product.
How should the company decide whether this
is worthwhile?
Financial Decision Making
How do we make a financial planning
model for a company?
How do we use this model to value a
company?
Should my company finance itself with
only equity? or a mixture of debt and
equity?
Wealth Maximization and Risk
Making optimal financial decisions is about
wealth maximization
Wealth-maximizing financial decisions involve
two elements:
Defining the parameters of the decision
Recognizing the risks of financial
decisions
Eight Principles of Finance
1. Buy assets that add value; avoid buying assets
that dont add value
2. Cash is king
3. The time dimension of financial decisions is
important
4. Know how to compute the cost of financial
alternatives
5. Minimize the cost of financing
Eight Principles of Finance (cont.)
6. Take risk into account
7. Markets are efficient and deal well with
information
8. Diversification is important
Why Excel
It allows you to get answers to practical
problems, which in turns, deepens your
understanding of the concepts involved.
It allows us to discuss many more real-life
examples dynamically.
Use Excel to do finance and youll have a
double advantage: Both in Finance and in
Excel
Excel 2003, Excel 2007, and
Excel 2010
All versions are basically the same
Differ in minor stuff (graphics, toolbars)
All spreadsheets for Fundamentals of Finance with
Excel work in all versions of Excel (though see
next slide)
Note: The Small Print
FFE files are saved in the Excel 2007/2010
format
To open in Excel 2003, download the
compatibility pack from Microsoft:
5 Rules for Financial Modelling
These rules will help you build better
spreadsheets

A good model:
Readability
Logic
Simplicity
Modelling Rule 1
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
A B C D E F G H I
Interest rate 8%
Annual deposit 12,000.00
Annual cost of college 35,000
Birthday
In bank on birthday,
before
deposit/withdrawal
Deposit or
withdrawal at
beginning of year
End of year
before
interest
End of year
with interest
10 0.00 12,000.00 12,000.00 12,960.00
11 12,960.00 12,000.00 24,960.00 26,956.80
12 26,956.80 12,000.00 38,956.80 42,073.34
13 42,073.34 12,000.00 54,073.34 58,399.21
14 58,399.21 12,000.00 70,399.21 76,031.15
15 76,031.15 12,000.00 88,031.15 95,073.64
16 95,073.64 12,000.00 107,073.64 115,639.53
17 115,639.53 12,000.00 127,639.53 137,850.69
18 137,850.69 -35,000.00 102,850.69 111,078.75
19 111,078.75 -35,000.00 76,078.75 82,165.05
20 82,165.05 -35,000.00 47,165.05 50,938.25
21 50,938.25 -35,000.00 15,938.25
NPV of all payments 6,835.64 <-- =C7+NPV(B2,C8:C18)
SAVING FOR COLLEGE
Critical parameters (sometimes called "value
drivers") are in the upper left-hand corner. The
actual of saving for a college education is
discussed in Chapter 2.
Try to put important variables in one place

Critical parameters (some times called
value drivers) are in the
upper left corner.

Modelling Rule 2

Never use a number where a formula will also
work
Use formulas instead of hard-wiring
numbers
Avoid using blank columns to accommodate cell
spillovers
Modelling Rule 3
Modelling Rule 4
Office Button
Excel Options
Make your Excel default one sheet
Modelling Rule 5
Turn off the auto jump-down feature
Excel default: When you hit Enter, the cursor
jumps down one cell
In finance, we need to carefully look at what
weve entered into the cell
So turn this off, go to
Office Button Excel Options Advanced.
Modelling Rule 5 (cont.)

Turn this thing OFF!

You need to see what youve
done!