Chapter-One

Introduction to Financial Modeling and Valuation

This chapter aims to give you some finance basics and their Excel implementation. If you have
had a good introductory course in Finance, this chapter is likely to be at best a refresher.
This chapter covers:
 Net present value (NPV)
 Internal rate of return (IRR)
 Payment schedules and loan tables
 Future value, Pension and accumulation problems
 Continuously compounded interest
1.1. Introduction to financial modeling
Financial modeling is the process of creating a summary of a company's expenses and earnings
in the form of a spreadsheet that can be used to calculate the impact of a future event or
decision. Financial modeling is one of the most highly valued, but thinly understood, skills in
financial analysis. The objective of financial modeling is to combine accounting, finance, and
business metrics to create an abstract representation of a company in Excel, forecasted into the
future.
There are many types of financial models, with a wide range of uses, including making business
decisions at a company, making investments in a private or public company, pricing securities,
or undergoing a corporate transaction such as a merger, acquisition, divestiture, or capital
raise. This financial modeling guide is designed to teach you the basics.
Why do you use Excel?
Forecasting a company’s operations into the future can be very complex. Each business is
unique and requires a very specific set of assumptions and calculations. Excel is used because
it is the most flexible and customizable tool available. Software, as an alternative, can be too
rigid and doesn’t let you understand each line of a business’ operations the way that Excel does.
The steps used for building a financial model
In this financial modeling for beginners and “dummies” guide, we have laid out the basic steps
of how to build a financial model.

1. Historical data – input at least 3 years of historical financial information for the
business.
 2. Ratios & metrics – calculate the historical ratios/metrics for the business, such as
margins, growth rates, asset turnover ratio, inventory changes, etc.
3. Assumptions – continue building the ratios and metrics into the future by making
assumptions about what future margins, growth rates, asset turnover, and inventory
changes will be going forward.
4. Forecast – forecast the income statement, balance sheet, and cash flow statement
into the future by reversing all the calculations you used to calculate historical ratios &
metrics. In other words, use the assumptions that you made to fill in the financial
statements.
5. Valuation – after the forecast is built, the company can be valued using the Discounted
Cash Flow (DCF) analysis method. Learn more about DCF models and valuation.

Uses of Financial Modeling

It can be done for various situations, e.g. valuation of a company, valuation of an asset, pricing
strategies, restructuring situations (merger & acquisition), etc.

Below are the areas in which Financial Modeling is generally used for:
 Who builds the Financial Models?

 Investment Bankers
 Credit Analysts
 Risk Analysts
 Data Analysts
 Portfolio Managers
 Investors
 Management/Entrepreneurs
 Equity Research Analysts

How much accounting knowledge is required?

In order to build a financial model, you need a solid understanding of accounting fundamentals.
You have to know what all the various accounts mean, how to calculate them, and how they’re
connected. We recommend having at least a few accounting courses under your belt.
Accounting is a prerequisite for financial modeling.

Excel skills Required for Financial Modeling Purpose

There are many Excel formulas and functions required to build a financial model. Here are a few
of the most common ones:

 SUM Function adds up a set of numbers.

 AVERAGE Function calculates the average of a set of numbers.
 COUNT Function counts the number of cells that contain numbers
 MIN and MAX Function calculate the minimum and maximum of a set of values.
 SUMPRODUCT Function multiplies two sets of arrays and adds the totals.
 IF Function is a logic-based formula that can make your model more dynamic.
 Charts & Graphs are an important part of financial modeling.
 Formatting skills can help separate great from good models, etc.
1.2. Basic Financial Calculations

Almost all Financial problems are centered on finding the value today of a series of cash receipts
over time. The cash receipts (or cash flows, as we will call them) may be certain or uncertain. The
present value of a cash flow CFt anticipated to be received at time t is
𝐶𝐹𝑡
(1+𝑟)𝑡
.The numerator of this expression is usually understood to be the expected time t cash flow

, and the discount rate r in the denominator is adjusted for the riskiness of this expected cash
flow—the higher the risk, the higher the discount rate. The basic concept in present value
calculations is the concept of opportunity cost. Opportunity cost is the return which would be
required of an investment to make it a viable alternative to other, similar investments. In the
financial literature there are many synonyms for opportunity cost, among them: discount rate, cost
of capital, and interest rate. When applied to risky cash flows, we will sometimes call the
opportunity cost the risk-adjusted discount rate (RADR) or the weighted average cost of capital
(WACC). It goes without saying that this discount rate should be risk-adjusted, and much of the
standard finance literature discusses how to do this. As illustrated below, when we calculate the
net present value, we use the investment’s opportunity cost as a discount rate. When we calculate
the internal rate of return, we compare the calculated return to the investment’s opportunity cost
to judge its value.

From now onwards, we will calculate the basic financial elements mentioned above (NPV, IRR,
FV, pensions, etc.) using Excel and are discussed as follows:

1.2.1. Present Value and Net Present Value

Both of these concepts are related to the value today of a set of future anticipated cash flows. As
an example, suppose we are valuing an investment which promises $100 per year at the end of
this and the next 4 years. We suppose that these cash flows are risk free: There is no doubt that
this series of 5 payments of $100 each will actually be paid. If a bank pays an annual interest rate
of 10% on a 5-year deposit, then this 10% is the investment’s opportunity cost, the alternative
benchmark returns to which we want to compare the investment. We can calculate the value of
the investment by discounting its cash flows using this opportunity cost as a discount rate:
 Computing The Present Value
Discount Rate 10%

Year Cash flow Present Value Formula

1 100 90.9091 C5=B5/(1+$B$2)^A5
2 100 82.6446 C6=B6/(1+$B$2)^A6
3 100 75.1315 C7=B7/(1+$B$2)^A7
4 100 68.3013 C8=B8/(1+$B$2)^A8
5 100 62.0921 C9=B9/(1+$B$2)^A9

Net Present Value

Summing Cells C5:C9 379.0787 NPV=SUM(C5:C9)
Using Excel's NPV Function 379.0787 NPV=NPV(B2,B5:B9)
Using Excel's PV Function 379.0787 PV=PV(B2,5,-100)

The present value, 379.08, is the value today of the investment. In a competitive market, the present value
should correspond to the market price of the cash flows. The spreadsheet illustrates three ways of obtaining
this value:

 Summing the individual present values in cells C5:C9. To simplify the copying, note the use
of “∧” to represent the power and the use of both the relative and absolute references; for
example: = B5/ (1 + $B$2) ∧ A5 in cell C5.
 Using the Excel NPV function. As we show on the next page, Excel’s NPV function is
unfortunately misnamed—it actually computes the present value and not the net present
value.
 Using the Excel PV function. This function computes the present value of a series of
constant payments. PV (B2,5, -100) is the present value of 5 payments of 100 each at the
discount rate in cell B2. The PV function returns a negative value for positive cash flows; to
prevent this unfortunate occurrence, we have made the cash flows negative.

The Difference Between Excel’ s PV and NPV Functions

The above spreadsheet may leave the misimpression that PV and NPV perform exactly the
same computation. But this is not true—whereas NPV can handle any series of cash flows,
PV can handle only constant cash flows:
 A B C D
Computing The Present Value
In this example the cash flows are not equal
Either discount each cash flow separately or use Excel's NPV
function
Excel's PV doesn't work for this case
Discount Rate 10%

Year Cashflow Present Value Formula

1 100 90.9091 C5=B5/(1+$B$2)^A5
2 200 165.2893 C6=B6/(1+$B$2)^A6
3 300 225.3944 C7=B7/(1+$B$2)^A7
4 400 273.2054 C8=B8/(1+$B$2)^A8
5 500 310.4607 C9=B9/(1+$B$2)^A9

Net Present Value

Summing Cells C5:C9 1065.2588 NPV=SUM(C5:C9)
Using Excel's NPV
Function 1065.2588 NPV=NPV(B2,B5:B9)

Excel’ s NPV Function Is Misnamed!

In standard finance terminology, the present value of a series of cash flows is the value
today of the future cash flows:
𝑁
𝐶𝐹𝑡
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 = ∑ ( )
(1 + 𝑟)𝑡
𝑡=1
The net present value is the present value minus the cost of acquiring the asset (the cash l
ow at time zero):

Excel’ s language about discounted cash flows differs somewhat from the standard finance
nomenclature. To calculate the finance net present value of a series of cash flows using Excel,
we have to calculate the present value of the future cash flows (using the Excel NPV function),
taking into account the time-zero cash flow (this is often the cost of the asset in question).
Suppose, for example, that the series of 5 cash flows of $100 is sold for $250(Initial Investment).
Then, as shown below, the NPV = 129.08.

Computing The Net Present Value

Discount Rate 10%

Year Cashflow Present Value Formula

0 -250 -250 C5=B5/(1+$B$2)^A5
1 100 90.9091 C6=B6/(1+$B$2)^A6
2 100 82.6446 C7=B7/(1+$B$2)^A7
3 100 75.1315 C8=B8/(1+$B$2)^A8
4 100 68.3013 C9=B9/(1+$B$2)^A9
5 100 62.0921 C10=B10/(1+$B$2)^A10

Net Present Value

Summing Cells C5:C9 129.0787 NPV=SUM(C5:C10)
Using Excel's NPV Function 129.0787 NPV=B5+NPV(B2,B6:B10)

The NPV represents the wealth increment of the purchaser of the cash flows. If you buy the
series of 5 cash flows of 100 for 250, then you have gained 129.08 in wealth today. In a
competitive market, the NPV of a series of cash flows ought to be zero: Since the present value
should correspond to the market price of the cash flows, the NPV should be zero. In other words,
the market price of our 5 cash flows of 100 ought—in a competitive market, assuming that 10%
is the correct risk-adjusted discount rate—be 379.08.

1.2.2. The Present Value of an Annuity—Some Useful Formulas

An annuity is a security which pays a constant sum in each period in the future. Annuities may
have a finite or infinite series of payments. If the annuity is finite, and the appropriate discount
rate is r, then the value today of the annuity is its present value:

Where, C is the periodic Payment(PMT) and r is the discount rate.

 If the annuity promises an infinite series of constant future payments, then this formula reduces
to:

Both of these formulas can be computed with Excel. Below we compute the value of a infinite
annuity in three ways: using the formula (cell B6), using Excel’ s PV function (cell B7), and using
Excel’ s NPV function:

A B C

COMPUTING THE VALUE OF A FINITE ANNUITY

1
2 Periodic Payment,C 1000
Number of future periods paid,
3 n 5
4 Discount Rate,r 12%
5 Present value of annuity
6 Using Formula 3604.78 B6=B2*((1-1/(1+B4)^B3)/B4)
7 Using Excel's PV Function 3604.78 B7=PV(B4,B3,-B2)
8
Annuity
9 Period Payment
10 1 1000 B10=B2
11 2 1000
12 3 1000
13 4 1000
14 5 1000
15
Present value using Excel's
16 NPV function 3604.78 B16=NPV(B5,B10:B14)
Computing the value of an infinite annuity is even simpler and is depicted below:

A B C

COMPUTING THE VALUE OF AN INFINITE ANNUITY

2 Periodic Payment,C 1000

3 Discount Rate,r 12%

4 Present value of annuity 8333.33 B4=B2/B3

 1.2.3. The Value of a Growing Annuity

A growing annuity pays out a sum C, which grows at a periodic growth rate g. If the annuity
is finite, its value today is given by:

Taking this formula and letting n → ∞, we can compute the value of infinite growing annuity:

These formulas can easily be implemented in Excel. Below we compute the value of a finite
growing annuity using the formula above and using Excel’ s NPV function (Check next slide):

When the growing annuity has an infinite life the formula to calculate the PV is depicted in the
below table:

A B C

COMPUTING THE VALUE OF INFINITE GROWING ANNUITY

1

2 Periodic Payment,C 1000

3 Growth rate of Payment,g 6%

4 Discount Rate,r 12%

5 Present value of annuity 16666.67 B5=B2/(B4-B3)
 As indicated in the preceding page, the below table shows the value for the PV of finite growing
annuity:
A B C
1 COMPUTING THE VALUE OF A FINITE GROWING ANNUITY
2 Periodic Payment,C 1000
3 Growth rate of Payment,g 6%
4 Number of future periods paid, n 5
5 Discount Rate,r 12%
6 Present value of annuity
B7=B2*((1-((1+B3)/(1+B5))^B4)/(B5-
7 Using Formula 4010.91 B3)
8
Annuity
9 Period Payment
10 1 1000 B10=B2
11 2 1060.00 B11=$B$2*(1+$B$3)^(A11-1)
12 3 1123.60 B12=$B$2*(1+$B$3)^(A12-1)
13 4 1191.02 B13=$B$2*(1+$B$3)^(A13-1)
14 5 1262.48 B14=$B$2*(1+$B$3)^(A14-1)
15
Present value using Excel's
16 NPV function 4010.91 B16=NPV(B5,B10:B14)

1.2.4. The Internal Rate of Return (IRR) and Loan Tables

The internal rate of return (IRR) is defined as the compound rate of return r which makes the NPV
equal to zero:
𝑁
𝐶𝐹𝑡
𝐶𝐹0 + ∑ ( )=0
(1 + 𝑟)𝑡
𝑡=1

To illustrate, consider the example given in rows 2–10 below: A project costing 800 in year zero
returns a variable series of cash flows at the end of years 1–5. The IRR of the project (cell B9) is
22.16%:
A B C
1 INTERNAL RATE OF RETURN
2 Year Cash Flows
3 0 -800
4 1 200
5 2 250
6 3 300
7 4 350
8 5 400
Internal Rate of
9 Return 22.16% B9=IRR(B3:B8)
Note that the Excel IRR function includes as arguments all of the cash flows of the investment,
including the first—in this case negative—cash flow of –800.

Determining the IRR by Trial and Error

There is no simple formula to compute the IRR. Excel’ s IRR function uses trial and error, which can
be simulated by using trial and error in a spreadsheet as illustrated below:

A B C
1 INTERNAL RATE OF RETURN
2 Discount Rate 12%
3
4 Year CashFlows
5 0 -800
6 1 200
7 2 250
8 3 300
9 4 350
10 5 400
11
12 Net present Value 240.81 B12=B5+NPV(B2,B6:B10)

By playing with the discount rate or by using Excel’ s Goal Seek (found under Data| What-if analysis,
we can determine that at 22.16% the NPV in cell B12 is zero:

A B C
1 INTERNAL RATE OF RETURN
2 Discount Rate 22.16%
3
4 Year CashFlows
5 0 -800
6 1 200
7 2 250
8 3 300
9 4 350
10 5 400
11
12 Net present Value 0.00 B12=B5+NPV(B2,B6:B10)
Here is the way the Goal Seek screen looked before we got the correct answer:

1.2.5. Loan Tables and the Internal Rate of Return

The IRR is the compound rate of return paid by the investment. To understand this fully, it helps to
make a loan table, which shows the division of the investment ’s cash flows between investment
income and the return of the investment principal.

The loan table divides each of the cash flows of the asset into an income component and a return
of-principal component. The income component at the end of each year is IRR times the principal
balance at the beginning of that year. Notice that the principal at the beginning of the last year
(327.44 in the example) exactly equals the return of principal at the end of that year.

Note: For the detail excel calculation, Refer the next page.
 A B C D E F
1 INTERNAL RATE OF RETURN
2 Year CashFlows
3 0 -800
4 1 200
5 2 250
6 3 300
7 4 350
8 5 400
9 Internal Rate of Return 22.16% B9=IRR(B3:B8)
10
11 USING THE IRR IN A LOAN TABLE
Division of cash flow between
B15=-B3 D15=$B$10*B15 investment income and return of
principal
12
Investment at
beginning of Cash flow at
Income
year end of year
13 Year Return of principal
14 1 800 200 177.28 22.72 E15=C15-D15
15 2 777.28 250 172.25 77.75
16 3 699.53 300 155.02 144.98
17 4 554.55 350 122.89 227.11
18 5 327.44 400 72.56 327.44
19 6 0.00
20 B16=B15-E15
21
The remaining investment principal in the
22 year after the last cash flow is zero,
23 indicating that all the principal has been
24 repaid.
25

We can use the loan table to find the internal rate of return. Consider an investment costing 1,000
today that pays off the cash flows indicated below at the end of years 1, 2, … 5. At a rate of 15%
(cell B2), the principal at the beginning of year 6 is negative, indicating that too little has been paid
out in income. Thus the IRR must be larger than 15%:
 A B C D E F
1 USING A LOAN TABLE TO FIND THE IRR
2 IRR? 15%
3

Division of cash flow

between investment income
and return of principal
4
Investment at Cash
beginning of flow at
Income
year end of
5 Year year Return of principal
6 1 1000 300 150.00 150.00 E6=C6-D6
7 2 850.00 200 127.50 72.50
8 3 777.50 150 116.63 33.38
9 4 744.13 600 111.62 488.38
10 5 255.74 900 38.36 861.64
11 6 -605.89
12 B7=B6-E6
13 D6=$B$2*B6
14

If the interest rate in cell B2 is indeed the IRR, then cell B11 should be 0. We can use Excel’ s Goal
Seek (found under Data|What-if analysis) to calculate the IRR:
As shown below, the IRR is 24.44%:

A B C D E F
1 USING A LOAN TABLE TO FIND THE IRR
2 IRR? 24.44%
3

Division of cash flow

between investment income
and return of principal
4
Investment at Cash
beginning of flow at
Income
year end of
5 Year year Return of principal
6 1 1000 300 244.36 55.64 E6=C6-D6
7 2 944.36 200 230.76 -30.76
8 3 975.13 150 238.28 -88.28
9 4 1063.41 600 259.86 340.14
10 5 723.26 900 176.74 723.26
11 6 0.00
12 B7=B6-E6
13 D6=$B$2*B6
14

The loan table is an effective illustration that the IRR is the interest rate that pays off an investment
over its term. As we have seen previously, of course, we could have simplified life by just using the
IRR function:
Excel ’s Rate Function

Excel’s Rate function computes the IRR of a series of constant future payments. In the example
below, we pay $1,000 today for an annual payment of $100 for the next 30 years. Rate shows that
the IRR is 9.307%:

A B C
USING EXCEL'S RATE FUNCTION TO
COMPUTE THE IRR
1
2 Initial investment 1000
3 Periodic cash flow 100
4 Number of payments 30
5 IRR 9.307% B5==RATE(B5,B4,-B3)

Note: Rate works much like PMT and PV discussed elsewhere in this chapter; it requires a sign
change between the initial investment and the periodic cash l ow (note that we have used –B2 in
cell B5). It also has switches to allow for payments which start today and payments which start one
period from now (not shown in the above example).

Note: It is also possible to encounter multiple IRRs in an investment decision and also
possible to calculate them (Interested learners can refer Simon_Benninga_Financial
Modeling 4th Edition Book on page 58).

1.2.6. Future Values and Applications

We start with a triviality. Suppose you deposit 1,000 in an account today, leaving it there for 10
years. Suppose the account draws annual interest of 10%. How much will you have at the end of
10 years? The answer, as shown in the following spreadsheet, is 2,593.74:

A B C D E
SIMPLE FUTURE VALUE
1
2 Interest 10%
3
Account
balance, Interest Total in
Year beginning earned account,
of Year during year end year
4
5 1 1000 100.00 1100.00 D5=B5+C5
6 2 1100.00 110.00 1210.00 D6=B6+C6
7 3 1210.00 121.00 1331.00
8 4 1331.00 133.10 1464.10
9 5 1464.10 146.41 1610.51 C5==$B$2*B5
10 6 1610.51 161.05 1771.56
11 7 1771.56 177.16 1948.72
12 8 1948.72 194.87 2143.59
13 9 2143.59 214.36 2357.95
14 10 2357.95 235.79 2593.74
15 11 2593.74 B6=D5
16
17 A Simpler Way 2593.74 BC17=B5*(1+B2)^10
As cell C17 in the preceding page shows, you don’t need all these complicated calculations: The
future value of 1,000 in 10 years at 10% per year is given by:

Now consider the following, slightly more complicated, problem: Again, you intend to open a savings
account. Your initial deposit of 1,000 today will be followed by a similar deposit at the beginning of
years 1, 2, …, 9. If the account earns 10% per year, how much will you have in the account at the
start of year 10?

This problem is easily modeled in Excel:

A B C D E
FUTURE VALUE WITH ANNUAL DEPOSITS
1
2 Interest 10%
Made today and at beginning of each of next 9 years
3 Annual Deposit 1000.00
4 Number of Deposits 10
5 Account
balance,
Deposit at Interest Total in
beginning of
Year beginning of earned account,
Year
6 yea during year end year
7 1 0 1000.00 100.00 1100.00 E7=B7+C7+D7
8 2 1100.00 1000.00 210.00 2310.00 E8=B8+C8+D8
9 3 2310.00 1000.00 331.00 3641.00
10 4 3641.00 1000.00 464.10 5105.10
11 5 5105.10 1000.00 610.51 6715.61 C7=$B$2*(B7+C7)
12 6 6715.61 1000.00 771.56 8487.17
13 7 8487.17 1000.00 948.72 10435.89
14 8 10435.89 1000.00 1143.59 12579.48
15 9 12579.48 1000.00 1357.95 14937.42
16 10 14937.42 1000.00 1593.74 17,531.17
17
18 Future Value $17,531.17 B18==FV(B3,B5,-B4,,1) B8=E7
Thus the answer is that we will have 17,531.17 in the account at the end of year 10. This same
answer can be represented as a formula that sums the future values of each deposit:

An Excel function: Note from cell B18 that Excel has a function FV which gives this sum. The dialog
box brought up by FV is the following:

We note three things about this function:

 For positive deposits FV returns a negative number. This is an irritating property of this
function, which it shares with PV and PMT. To avoid negative numbers, we have put the PMT
in as − 1,000.

 The line Pv in the dialog box refers to a situation wherein the account has some initial value
other than 0 when the series of deposits is made. In the above example, this has been left
blank, which indicates that the initial account value is zero.
 As noted in the picture, “Type” (either 1 or 0) refers to whether the deposit is made at the
beginning or the end of each period (in our example the former is the case).
1.2.7. A Pension Problem—Complicating the Future Value Problem

A typical exercise is the following: You are currently 55 years old and intend to retire at age 60.
To make your retirement easier, you intend to start a retirement account:

 At the beginning of each of years 1, 2, 3, 4 (that is, starting today and at the beginning
of each of the next four years), you intend to make a deposit into the retirement
account. You think that the account will earn 8% per year.
 After retirement at age 60, you anticipate living 8 more years. 5 At the beginning of
each of these years you want to withdraw $30,000 from your retirement account. Your
account balances will continue to earn 8%.
How much should you deposit annually in the account? The following spreadsheet fragment
below shows how easily you can go wrong in this kind of problem—in this case, you have
calculated that in order to provide $30,000 per year for 8 years, you need to contribute
$240,000/5 = $48,000 in each of the first 5 years. As the spreadsheet shows, you will end up
with a lot of money at the end of 8 years! (The reason—you have ignored the powerful effects
of compound interest. If you set the interest rate in the spreadsheet equal to 0%, you willl see
that you ’ re right.)
A B C D E F
A RETIREMENT PROBLEM
1
2 Interest 8%
3 Annual Deposit 48,000.00
4 Annual retirement withdrawal 30,000.00
5 D7==$B$2*(B7+C7)
Account
Interest
balance, Deposit at Total in
beginning earned
Year beginning of account,
of Year during
yea end year
year
6
7 1 0 48000.00 3840.00 51840.00 E7=B7+C7+D7
8 2 51840.00 48000.00 7987.20 107827.20
9 3 107827.20 48000.00 12466.18 168293.38
10 4 168293.38 48000.00 17303.47 233596.85
11 5 233596.85 48000.00 22527.75 304124.59
12 6 304124.59 -30000.00 21929.97 296054.56
13 7 296054.56 -30000.00 21284.36 287338.93
14 8 287338.93 -30000.00 20587.11 277926.04
15 9 277926.04 -30000.00 19834.08 267760.12
16 10 267760.12 -30000.00 19020.81 256,780.93
17 11 256780.93 -30000.00 18142.47 244,923.41
18 12 244923.41 -30000.00 17193.87 232,117.28
19 13 232117.28 -30000.00 16169.38 218,286.66

Note: This problem has 5 deposits and 8 annual withdrawals, all made at the beginning of the year. The
21 beginning of year 13 is the last year of the retirement plan; if the annual deposit is correctly computed, the
balance at the beginning of year 13 after the withdrawal should be zero.
There are several ways to solve this problem. The first involves Excel’s Solver. This can be found
on the Data menu.

Note: If the Solver does not appear on the Tools menu, then you have to load it. Go to
File|Options|Add-ins and click Solver Add-In on the list of programs. Note that you could also
use the Goal Seek tool to solve this problem. For simple problems such as this one, there is not
much difference between the Solver and Goal Seek; the one (not inconsiderable) advantage of
the Solver is that it remembers its previous arguments, so that if you bring it up again on the
same spreadsheet, you can see what you did in the previous iteration. In later chapters we will
illustrate problems that cannot be solved by Goal Seek and in which the use of the Solver is a
necessity.

Clicking on Solver opens a dialog box. Below we have filled it in:

 A A RETIREMENT
B PROBLEM
C D E F
1
2 Interest 8%
3 Annual Deposit 29,386.55
4 Annual retirement withdrawal 30,000.00
5 Account D7==$B$2*(B7+C7)
balance, Interest
Deposit at Total in
beginning earned
Year beginning account,
of Year during
of yea end year
6 year
7 1 - 29,386.55 2,350.92 31,737.48 E7=B7+C7+D7
8 2 31,737.48 29,386.55 4,889.92 66,013.95
9 3 66,013.95 29,386.55 7,632.04 103,032.54
10 4 103,032.54 29,386.55 10,593.53 143,012.62
11 5 143,012.62 29,386.55 13,791.93 186,191.10
12 6 186,191.10 (30,000.00) 12,495.29 168,686.39
13 7 168,686.39 (30,000.00) 11,094.91 149,781.30
14 8 149,781.30 (30,000.00) 9,582.50 129,363.81
15 9 129,363.81 (30,000.00) 7,949.10 107,312.91
16 10 107,312.91 (30,000.00) 6,185.03 83,497.94
17 11 83,497.94 (30,000.00) 4,279.84 57,777.78
18 12 57,777.78 (30,000.00) 2,222.22 30,000.00
19 13 30,000.00 (30,000.00) 0.00 0.00

Solving the Retirement Problem Using Financial Formulas

We can now use Excel’s PV and PMT functions to solve the problem:

A B C
A RETIREMENT PROBLE
1 COMPUTE THE IRR
2 Interest 8%
3 Annual retirement withdrawal 30,000.00
4 Years of withdrawal 8
5 Year of Deposit 5

6 Present value of withdrawals 117,331.98 B6=-PV(B2,B4,B3)/(1+B2)^B5

7 Annual deposit 29,386.55 B7=PMT(B2,B5,-B6)