Students in corporate finance classes at Illinois State University’s College of Business rely on Palisade’s @RISK. Dr. Domingo Castelo Joaquin teaches Advanced Corporate Finance in a special MBA program for executives and managers from Archer Daniels Midland and other neighboring firms such as Caterpillar, and he also teaches undergraduate seniors in the University’s College of Business. Both groups of students use @RISK to learn advanced financial analysis techniques using Monte Carlo simulation.
Why Monte Carlo Simulation with @RISK?
Dr. Joaquin holds advanced degrees in theoretical statistics and business administration, and he is an advocate of Monte Carlo simulation and @RISK because they offer a pragmatic approach to dealing with the uncertainties that are inherent in any business decision: “Since the future is unknown,” he says, “it would be implausible to use point estimates to represent future values of critical success factors. Range estimates are an improvement, but @RISK is even better because it is able to reflect the important fact that some values within the plausible range may be more likely than others. More than that, the correlation capability of @RISK allows the analyst to model the fact that co-movements of variables in the same direction may not be as likely as co-movements in the opposite direction.”
Dr. Domingo Castelo Joaquin
College of Business, Illinois State University
Real-World Problems in the Classroom
Dr. Joaquin’s teaching with @RISK takes place in a computer lab, which allows each student hands-on opportunities to follow his lectures and demonstrations. He guides them in using @RISK to address an array of thorny problems in real options analysis––his area of research specialization––as well as in capital budgeting, cash budgeting, capacity planning, and international portfolio diversification.
Whether it be in the undergraduate class or in the MBA class, certain questions frequently arise, like “How do know I have the right distribution? What happens if somebody else at the company gets a different answer?” He responds to these concerns by explaining that variation in results is normal. “What is important is to come up with credible distributions and credible conclusions. Arriving at this requires a mixture of objective analysis, subjective projections based on experience, and informed judgment from the experts.”
Another frequently asked question is “How do I convince my boss that the simulation is credible?” Responding to this, Dr. Joaquin offers a strong piece of strategic advice: “Enlist the participation of different departments in the creation of the simulation from the very beginning. Get their input in making the original assumptions. Early on, be sure to involve the higher-ups in painting the big picture and in evaluating the general structure of the model––you’ll find, for instance, that using the tornado diagram to evaluate the sensitivity of the outcomes to each of the input variables in your simulation is particularly useful in focusing their attention on the factors that matter most to their organizations.”
Dr. Joaquin’s students at both levels are eager to explore all the capabilities of @RISK. He attributes this to the software’s user friendliness. “Just like Excel itself, @RISK does its work without involving you in its computational complexities. So students who may have been scared of stats and data analysis before can feel perfectly at ease creating their simulations––and so, they want to do more.”
Real Zingers on the Exam
When exam time comes, Dr. Joaquin cooks up with a zinger of a business case and asks the students to fire up their computers and send him the deliverables—their executive memos with recommendations and the spreadsheet work in @RISK that led to these conclusions.
His cases are complex, just like situations in everyday corporate life. But Dr. Joaquin believes that @RISK puts the resolutions of the exam case within reach of most of his students. “@RISK represents a major advance in the business analyst’s toolkit. By sparing the analyst the trouble of having to reinvent simulation in an Excel environment, @RISK allows the analyst to focus on structuring problems that make managerial sense and on interpreting results for the purpose of supporting executive decisions.”