Teaching Monte Carlo Simulation Using a Multi-Sheet Excel Workbook

Abstract

One of the challenges in finance education is to get across the importance of taking risk into consideration when making capital investment decisions. Once risk information is collected, it is up to the decision maker how to use it, which brings in differing approaches from manager to manager. The availability of risk indicators, however, is a valuable element in the decision process.

One strategy that seems to provide robust input for these decisions is the use of simulation to illustrate the variability of critical values, such as a net present value. A simulation may capture several key input variables’ deviations. Typical inputs exhibiting uncertainty are sales growth, fixed and variable costs, and tax rates. Some argue that the cost of capital is variable as well, although these are determined nominally at the time of financing, usually at the outset of a project, and thus may not be as needy of simulation. This article demonstrates a teaching technique for using a simulation case.