I need to solve part 2 of this problem, the case problem description is pasted b
ID: 1169018 • Letter: I
Question
I need to solve part 2 of this problem, the case problem description is pasted below. I specifically need to know how to incorporate a random variable to the annual salary& portfolio growth rates into the simulation model as highlighted in the last paragraph of the problem description. I need to know what the formula is for the specific cells that need to be changed to cause the simulation model to work. The simulation should have different results each time it is ran so I know it has something to do with RAND() or maybe =NORMINV(RAND() of something… but where and how? I have tried using the formala =NORMINV(RAND(),Mean,Standard Devation) into the different cells, to account for the Random Variable, but it is not working. The simulation causes all zeros, duplication of the same amounts, etc. I need someone to specifically point out which cells need to be changed, ie. C13: CHANGE TO XXX, D13: =xxxx, etc. I have also included the formulas that I used to solve part 1 of the problem (on the graphic).
Tri-State Corporation
What will your portfolio be worth in 10 years? In 20 years? When you stop working? The
Human Resources Department at Tri-State Corporation was asked to develop a financial planning model that would help employees address these questions. Tom Gifford was asked to lead this effort and decided to begin by developing a financial plan for himself. Tom has a degree in business and, at the age of 25, is making $34,000 per year. After two years of contributions to his company’s retirement program and the receipt of a small inheritance,
Tom has accumulated a portfolio valued at $14,500. Tom plans to work 30 more years and hopes to accumulate a portfolio valued at $1,000,000. Can he do it?
Tom began with a few assumptions about his future salary, his new investment contributions, and his portfolio growth rate. He assumed 5% annual salary growth rate as reasonable and wanted to make new investment contributions at 4% of his salary. After some research on historical stock market performance, Tom decided that a 10% annual portfolio growth rate was reasonable. Using these assumptions, Tom developed the Excel worksheet shown in Figure 16.18. Tom’s specific situation and his assumptions are in the top portion of the worksheet (cells D3:D8). The worksheet provides a financial plan for the next five years. In computing the portfolio earnings for a given year, Tom assumed that his new investment contribution would occur evenly throughout the year, and thus half of the new investment could be included in the computation of the portfolio earnings for the year. Using Figure 16.18, we see that at age 29, Tom is projected to have a portfolio valued at $32,898.
Tom’s plan was to use this worksheet as a template to develop financial plans for the company’s employees. The assumptions in cells D3:D8 would be different for each employee, and rows would be added to the worksheet to reflect the number of years appropriate for each employee. After adding another 25 rows to the worksheet, Tom found that he could expect to have a portfolio of $627,937 after 30 years. Tom then took his results to show his boss, Kate Riegle.
Although Kate was pleased with Tom’s progress, she voiced several criticisms. One of the criticisms was the assumption of a constant annual salary growth rate. She noted that most employees experience some variation in the annual salary growth rate from year to year. In addition, she pointed out that the constant annual portfolio growth rate was unrealistic and that the actual growth rate would vary considerably from year to year. She further suggested that a simulation model for the portfolio projection might allow Tom to account for the random variability in the salary growth rate and the portfolio growth rate.
After some research, Tom and Kate decided to assume that the annual salary growth rate would vary from 0% to 10% and that a uniform probability distribution would provide a realistic approximation. Tri-State’s accounting firm suggested that the annual portfolio growth rate could be approximated by a normal probability distribution with a mean of 10% and a standard deviation of 5%. With this information, Tom set off to develop a simulation model that could be used by the company’s employees for financial planning.
Managerial Report
Play the role of Tom Gifford and develop a simulation model for financial planning. Write a report for Tom’s boss and, at a minimum, include the following:
1. Without considering the random variability in growth rates, extend the worksheet in
Figure 16.18 to 30 years. Confirm that by using the constant annual salary growth rate and the constant annual portfolio growth rate, Tom can expect to have a 30-year portfolio of $627,937. What would Tom’s annual investment rate have to increase to in order for his portfolio to reach a 30-year, $1,000,000 goal?
I confirmed that with a 30-year plan he can expect to have a portfolio of $627,937.
If Tom’s wants to have his portfolio reach a $1million goal in 30-years, he would need to increase his investment another 4%, bringing to a yearly investment of 8%, with a projected portfolio of $1,002,857. With the formula already established it is as easy as changing the annual investment rate and checking the ending portfolio results at the end of the 30 years.
2. Incorporate the random variability of the annual salary growth rate and the annual portfolio growth rate into a simulation model. Assume that Tom is willing to use the annual investment rate that predicted a 30-year, $1,000,000 portfolio in part 1. Show how to simulate Tom’s 30-year financial plan. Use results from the simulation model to comment on the uncertainty associated with Tom reaching the 30-year, $1,000,000 goal. Discuss the advantages of repeating the simulation numerous times
Explanation / Answer
Ans:
2)Controllable inputs: Portfolio investment years, Current Salary, Current beginning portfolio
& Annual investment rate.
Probabilistic inputs: Salary Growth rate & Annual portfolio growth rate
Outcome of interest: Ending portfolio balance at year 30 > $1 million
The probability distributions that have been suggested by Kate and Toms research to
simulate probabilistic inputs are:
Salary growth rate uniform probability distribution from 0 to 10%.
Annual portfolio growth rate normal distribution with mean of 10% and standard deviation of 5%