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There are several basic steps one must do in order to do a risk analysis in Excel with the

Risk Analyzer
The first step is to create a model of your study. This is an Excel workbook that you
create that has the following:
Cells that you use to enter numeric values. Examples of such cells are:
Budget for the accounting group
Budget for the marketing group
Budget for the administrative group
Investment to build a building
Selling price of a product
Amount of a product to be sold
Cost to make a product
These cells are referred to as input cells or input variables or
sensitivity variables. Input cells are cells that contain just
numbers.
Cells that contain formulas and return a value that you are interested in.
Examples of such cells are:
The total of all the budgets
The return on investment
These cells are referred to as output cells or output variables. Output
cells are cells that contain formulas.
The Risk Analyzer identifies such cells by the use of range names. Range names are a
feature of Excel that assigns a name to a cell. If you move the cell, the name moves
with it.
To create a name select a cell and click in the name box which is to right of the formula
box and has the cell address in it. Then type a name, with no spaces. After you type in
the name, press enter - do not click elsewhere as you must press enter to create the
name Once you have created the name, the cell address in the name box is replaced by
the name you create. Instead of spaces, use underscores, "_"
The alternate way to create a range name is to select a cell and then press
CTL-F3. In the dialog that appears, type in a name (no spaces allowed) and
click on the ADD button. You will notice that Excel often suggests a logical
name.
To better understand creating range names, practice creating them a new workbook.
Type some text or number entries in several cells and then create a range name for each
cell using the approaches above.
BASIC STEPS IN RISK ANALYSIS IN EXCEL
Investment Study Example
Do not create the range names in this file. as the
names that are needed have already been created.
Your models (Excel workbooks) can be as simple as you want or as complex as you
want. The budget example that comes with the Risk Analyzer is a very simple model.
The investment example is more complex.
Once you have created your model, the next steps are to:
Create a risk analysis premise file
Define and create probability distributions
Create and review the sensitivity variable reports
Run simulations
Fine tuning histograms and output table appearance
A risk analysis premise file is a workbook that stores the key assumptions on your
risk analysis. It is created and used by the Risk Analyzer via a series of questions and
dialog selections.
Probability distributions represent the likelihood that a given value will occur. The
higher the peak of the cure, the more likely a value associated with the peak will occur.
The following pictures reflect some of the probability distributions one can use.
The normal distribution represents variables whose values are
most likely to be in the middle of the range, and with values
away from the middle equally likely to happen in either
direction.
A beta distribution is similar to a normal, but skewed to the left
or to the right, and the values away from the center have a
greater likelihood of happening.
A uniform distribution is one you would use when any value
along a range of values has an equal likelihood of happening.
A gamma distribution is highly skewed
in one direction or another.
A triangular distribution is often the easiest to create, as you
decide on the min, max, and most likely values. It often weights
the values away from the most likely value heavier than the normal
or gamma distributions, which puts more "risk range" in your study.
In addition to the above distributions, the Risk Analyzer allows you to create
exponential distributions, Poisson distributions, discrete distributions and custom
distributions. Most Risk Analysis studies do not use these distributions.
Although the normal distribution is the one most taught in school and college, the
gamma distributions and the triangular distributions are the ones that are most often
representative of the distribution of real world variables.
The option to create sensitivity reports gives you a documentation page on the
probability assumptions you have made in your study. And it creates sensitivity charts.
The following illustrates a typical probability curve. The area under the black curved line
is the likelihood that a value will occur. The blue lines are the + or - 10% points, called
the 10/90 points. There is a 20% chance that the input variable will be outside of the
10/90 points, with it being 10% likely that it will be less then the smaller 10/90 point and
a 10% chance it will be greater than the larger 10/90 point. The red line represents the
value in the study file.
The sensitivity charts that the Risk Analyzer creates are just a way to show which
variables have the biggest effect on the outcome of your study. They also show if
the assumptions on the variables are skewed toward an optimistic view or a pessimistic
view of the world.
A sensitivity chart looks like the following:
Expected Profit Sensitivity To Key
Variables
0
10,000
20,000
30,000
40,000
50,000
60,000
E
x
p
e
c
t
e
d

P
r
o
f
i
tConstruction_
Cost
Demolition
Environmental
Engineering
Equipment_R
entals
The horizontal line represents the study case. The vertical lines represent the output variable range between the sensitivity variables' 10/90 values. Sensitivity variables
with long vertical lines have the most effect on the output variable.
Construction Cost
Study Min Max
File Allowed Expected Allowed
Value Value 10/90 Value 10/90 Value
520,000 470,000 508,188 526,327 541,393 550,000
Gamma right distribution
460,000 480,000 500,000 520,000 540,000 560,000
27% <= Study value
The horizontal line represents the case you have set up in your Excel model.
Typically, it is the most likely case. Sometimes, it is the case that
management wishes were the most likely case.
Each vertical line represents the change in the output variable due to a change
in an input variable. The end points represent the input variable values that have
a 10% chance of occurring or a 90% chance. Often these points are referred to
as the 10/90 points and 90/10 points..
Examination of such charts give you a feel for which variables affect the outcome
and in what direction.
The Risk Analyzer does all the work when you run simulations. All you do is select
which variables to use in the study and how many simulations to run. Typically, you
would run 3000 to 5000 simulations, which would take 1-3 minutes.
As nice output is always important, the option to fine tune the histograms and tables
which are the main output is easy to do.
The next worksheet will walk you through the risk analysis of the investment study.
Expected Profit Sensitivity To Key
Variables
0
10,000
20,000
30,000
40,000
50,000
60,000
E
x
p
e
c
t
e
d

P
r
o
f
i
tConstruction_
Cost
Demolition
Environmental
Engineering
Equipment_R
entals
The horizontal line represents the study case. The vertical lines represent the output variable range between the sensitivity variables' 10/90 values. Sensitivity variables
with long vertical lines have the most effect on the output variable.
Risk Analyzer Example File Instructions
GENERAL
This is one of three example files to use with the Risk Analyzer. You should print this
sheet so that you have it as a guide when you use the Risk Analyzer.
The sheet titled 'Investment Study" contains an economic model of investing in
manufacturing facilities to make a product. The purpose of this example file is to determine
the likely return on investment (IRR) that the company will get from their investment.
CREATING A RISK ANALYSIS PREMISE FILE
The first step is to create a risk analysis premise file. Do so by selecting the option to
do so from the Risk Analyzer menu. Specify this file as the study file.
When prompted for the title, you may use the default title (the name of this file)
or specify any title you wish
You will next be asked to specify your output variables. Two are listed on the
selection form:
Net_Present_Value (primary output variable)
Rate_Of_Return
Select both and click ok.
Once you select these, you will then be prompted to select your primary output
variable. This variable is used to sort the sensitivity variables in order of importance.
Select Net_Present_Value as the primary output variable.
You will then be prompted for the input or sensitivity variables. All those listed
may be selected. They are:
Fixed_Cost_Per_Year
Investment
Marketing_Cost_Percent
Price
Shipments_Per_Year
Variable_Cost_Per_Unit
Save the file once it is created.
INSTRUCTIONS FOR USING THIS EXAMPLE
page 5
Risk Analyzer Example File Instructions
DEFINING AND CREATING PROBABILITY DISTRIBUTIONS
Once you save the risk analysis premise file, click on the Risk Analyzer button to display
the main menu.
Select the option to define/change sensitivity variables probability distributions. Please use
the following distributions, minimum values, and maximum values. Use the X axis
minimum to improve the appearance of the graphs
The minimum and maximum values are input on the first dialog when you initially set a variable's
distribution. They can be changed on the distribution dialog. The X axis minimum are input
on the distribution dialog. Typically, you do not need to set X axis maximums.
Sensitivity Min Max X Axis
Variables Distribution Value Value Min
Fixed_Cost_Per_Year Normal 10,000 20,000 10,000
Investment Beta 40,000 75,000 40,000
Marketing_Cost_Percent Uniform 5.0% 10.0% 0.0%
Price Gamma Left 6.00 7.00 5.50
Shipments_Per_Year Gamma right 7,000 10,000 6,000
Variable_Cost_Per_Unit Triangular 2.75 3.50 2.00
The distribution dialog shows a chart of the probability of a distribution. The more area under
the curve, the more likely values in that range are likely to occur.
CREATING PROBABILITY DISTRIBUTION CHARTS
You can use the option on the Risk Analyzer menu to create the sensitivity variables
distribution report. This allows you to confirm that the distributions are what you want. It
also provides a report that you can use to share with others.
CREATING SENSITIVITY CHARTS
Once you have defined the distributions, use the options on the Risk Analyzer menu to
create the sensitivity charts. These charts plot the expected values of the output
variables assuming that a sensitivity variable is set to its 10% and 90% values. This range
represents 80% of the likely values of a sensitivity variable.
If a sensitivity value falls outside its 10/90 range, its sensitivity line will not intersect
the expected value line.
When the sensitivity charts are created, the variance contribution for each variable is calculated.
The variance contribution indicates how much each sensitivity variable affects the value of your
primary output variable.
page 6
Risk Analyzer Example File Instructions
RUNNING SIMULATIONS
Once the above are created, select the option to run simulations. Specify 3000 simulations
and select all the variables. The simulation run will typically take one to two minutes to
run. You should select the sensitivity variables in descending order of their variance
affect on your primary output variable. This variance is shown in column A next to the
sensitivity variable. It is calculated by the Risk Analyzer when the sensitivity charts
are created.
You may get a message at the end of the simulation runs that advise that some of
the output variables could not be calculated This typically happens if your model is
calculating a return on investment (or similar value) and Excel can not find a solution.
To avoid, you may need to write equations for IRR like those illustrated at the bottom
of the sample file's Economics worksheet.
If the number of output variable that can not be solved is small, then the results of the
simulations for that variable are valid. If a significant number of the cases can not be
solved, then the results may be skewed and you should modify your formulas (as
illustrated on the Economics worksheet) to provide solutions. To help you test your
modifications, the Risk Analyzer provides debug options to set your study to a given
case and to reset back to the base case values.
3000 simulations runs is typically all that you need. If the distribution histograms
that are created are not smooth, you can make additional runs. If you have already
made a set of runs, you are given the option to make additional runs. We
recommend that you make an additional run of 2000 more simulations so that you
see how this works.
If you change your model, you should always use the start over / clear option. If you
do not, the results will not be representative of your model.
FINE TUNING HISTOGRAMS
Once you have run enough cases to get an understanding of the range of your output
variables, you can use this information to customize the histograms. For example, you
may want to set the start and end value for the bins, and the step size. Setting these
values give a much more professional appearance to your output. On the Risk Premises
sheet, change the histogram settings from "auto" to the following:
When you specify such values in your studies, you should have at least 10 bins, and
preferably 20 or more bins.
Use the fine tune histogram option to redo the histograms.
If you change the format of the output variable in your study file, then the appearance
of the from-to values on the histograms will reflect this change if you re-create the
histograms. To illustrate this, format the Rate of Return cell to 0% (no decimal) and
recreate the histogram via the fine tune histogram option.
Output
Variables Min value Max value Step size
Net_Present_Value (75,000) 100,000 5,000
Rate_Of_Return -30% 50% 2%
Histogram settings
page 7
EXCEL SPREADSHEET MODEL
Yellow cells are the 26,077 Net Present Value 20.6% Rate of Return
sensitivity cells
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
PREMISES:
Shipments per year 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000
Price Per unit 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50
Variable Cost Per Unit 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00
Fixed Cost 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000
Marketing Cost as % of Revenue 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%
Investment 58,000
FINANCIALS:
$'s $'s $'s $'s $'s $'s $'s $'s $'s $'s $'s
Revenue 58,500 58,500 58,500 58,500 58,500 58,500 58,500 58,500 58,500 58,500
Cost:
Variable Cost 27,000 27,000 27,000 27,000 27,000 27,000 27,000 27,000 27,000 27,000
Fixed Cost 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000
Depreciation 5,800 5,800 5,800 5,800 5,800 5,800 5,800 5,800 5,800 5,800
Marketing Costs 4,680 4,680 4,680 4,680 4,680 4,680 4,680 4,680 4,680 4,680
—— —— —— —— —— —— —— —— —— ——
Total Cost 52,480 52,480 52,480 52,480 52,480 52,480 52,480 52,480 52,480 52,480
Pre Tax Earnings 6,020 6,020 6,020 6,020 6,020 6,020 6,020 6,020 6,020 6,020
Taxes 2,288 2,288 2,288 2,288 2,288 2,288 2,288 2,288 2,288 2,288
—— —— —— —— —— —— —— —— —— ——
After Tax Earnings 8,308 8,308 8,308 8,308 8,308 8,308 8,308 8,308 8,308 8,308
Cash Flow By Year (58,000) 14,108 14,108 14,108 14,108 14,108 14,108 14,108 14,108 14,108 14,108
IRR CALCULATIONS
Initial Guess none -0.1 -0.2 -0.3 0.1 0.2 0.4
IRR 21% 21% 21% 21% 21% 21% 21%
this approached used as the default initial guess may
not be close enough to converge to a solution