This is a guest post written by Paramdeep from Pristine. Chandoo.org is partnering with Pristine to bring an excel financial modeling online training program for you.
This is Part 6 of 6 on Financial Modeling using Excel
In this tutorial we are going to learn how to build assumptions & input sheets in our excel financial model. The 6 parts of this tutorial are,
- Introduction to Financial Modeling
- Building a layout for Project Evaluation Model – Best practices
- Building Inputs and Assumptions Sheet
- Building Projections for Project Evaluation
- Modeling the Cash Flow Statement and Projections
- Putting it all together – Final Project Evaluation Model
- Join our Financial Modeling Classes
I am sorry for the slight delay in the post. Things have been very hectic for the last few weeks as we were just completing our training on Financial Modeling in Excel – Real Estate (RE) sector for JP Morgan. The real estate valuation is very similar to the project evaluation that we are doing for the simple reason:
- Project evaluation and real estate valuation are limited duration projects (If you intend to sell the RE project in near future) unlike general companies (which are an on-going concern)
- For both these the timing of the cash is very important. A delay in the timing might appear to be ok for the developer, but the investor’s calculations (typically IRR) go for a toss
In India most of the RE developers are businessmen, who are concerned about the cash that the project generates. They are not really too bothered if they receive it in April or September (After all they are getting the cash). But the investors are really bothered by these delays – Some PE investors have a limited period investment horizon and some are too concerned about the IRR generated by the project. As we figured out in our class, Real estate projects are very sensitive to delays in cash generation! Excel is a great tool to show this effect in a matter of 30 secs (Use XIRR and data-tables). Maybe I will write about this functionality in one of my posts later!
For the time being lets come back to our project.
What is time value of money?
Let me start with a very simple to understand example.
- If you invest $100 in bank today, what would be its value 1 year down the line (assuming 10% interest rate)?
- The value should be 100*(1+10%) = $ 110.
- Now if you keep this invested for another year, what would be its value 2 years down the line?
- The value should be 110*(1+10%) = $ 121. I can also write it as 110*(1+10%)^2
- Similarly if you keep invested for 10 years, the value would be 110 * (1+10%)^10
This is the simple concept of compounding.
The inverse of this concept (What if you wanted $110 after 1 year, or 110*(1+10%)^10 after 10 years), how much should you invest today, is called discounting. Clearly $100 today is worth $110 a year after and $121 two years hence.
If I have more than 1 cash flows, I can discount them depending on the time duration and if I sum them all, its called Net Present Value (NPV) of all cash flows. We would take the outflows as Negative Cash and inflows as Positive Cash.
In excel, you can either discount all cash flows or calculate the NPV of the project by using the function =NPV(Discount Rate, Cash)
What is the rate on which money should be discounted?
When equity investors invest, they take greater risk as compared to banks lending money. Obviously their expectation of return would be higher. In some cases, the equity investor might have a return figure in mind (Based on the risk I am taking, I would like to have Min. 15% return on my invested money).
Sometimes, this expected return can be calculated by using the capital asset pricing model (CAPM). What this states is very simple – Equity investors want a premium apart from the risk free rate (Lets call this expectation of equity investors as Re) . So there are two parts to the return expectation:
Re = Risk Free + Premium apart from Risk free
Now this premium depends on how much risk I am taking (Typically measured with respect to the volatility in returns with respect to the benchmark index). So I say:
Re = Risk Free + Beta * (Market Returns – Risk Free Returns)
The beta measures the movement of your returns with respect to market returns.
Now apart from the equity investors, there would be some debt in the project. Typically debt holders expect a lower return (Lets call it Rd).
The overall expectation of return from the project is the weighted average of these returns, Re and Rd.
To create this switch in the model, I have used data-validation (so that the user can just input one of these options)
To create such a drop down, use data validation – list option in excel
Internal Rate of Return
The same concept can be viewed from a return angle as well. If I can calculate a discount rate that makes the present value of the expected cash inflows just equal to the initial cost of the project, then that rate would be sort of a break even rate for me (Considering the time value of money). This rate is called the Internal rate of return (IRR).
Many investors have a certain hurdle IRR in mind and if the project is generating an IRR less than the hurdle IRR, they would not invest in the project.
To calculate IRR, there is no analytical solution possible. You can use the excel function =IRR(Cash) to get the IRR of the cash flows.
Making a decision in our case
First let me summarize the decision criteria for you. I would invest in the project based on the following conditions:
NPV Rule:
- If NPV > 0: The project may be accepted (Please note that positive NPV is not a sufficient condition)
- If NPV = 0: The investor should be indifferent
- If NPV < 0: The project must not be accepted (Please note that positive NPV is a necessary condition)
Please note that sometimes people might decide to take on the project even though the NPV is negative!
IRR Decision Rule
- If IRR > the required rate of return, accept the project
- If IRR < the required rate of return, reject the project
In our case, we are getting the NPV to be 21 and an IRR to be 12%. In this case it’s a borderline case and my feeling is that Mr. Samar would invest in the project (After all Mohit is his son!!) J.
Download Project Valuation Templates
I have created a template for you, where the subheadings are given and you have to link the model to get the cash numbers! You can download the same from here:
Project Valuation Template – Blank
You can go through the case and fill in the yellow boxes. I also recommend that you try to create this structure on your own (so that you get a hang of what information is to be recorded).
Also you can download this filled template and check, if the information you recorded, matches mine or not! 😉
Project Valuation Template – Solution
I am just doing that for the single sheet model and recommend that you do the same for multi-sheet model as a homework problem. If you face any issue, post your excel with the exact problem and we can discuss the way to move forward.
Next Steps
We are not done with a basic model for evaluation of a project. There are other nuances that we could not tackle (Given the time and space constraint) – What if the cash does not come at year end, what could be the scenarios in which this project is not a viable project, what can be done to make the project more interesting, etc. I do hope that you found the posts interesting and look forward to your comments and suggestions!
Read previous part of this series – Modeling Cash-flow projections
How do you make project investment decisions?
We are very eager to learn from your experience and know your ideas. What methods of valuation do you use? How do you model them? Share using comments.
Join our Financial Modeling Classes:
Chandoo.org is partnering with Pristine to bring an online financial modeling training program for you. Click here to learn more about our financial modeling class & join.
Added by Chandoo:
Thank you Paramdeep & Pristine:
Many thanks to Paramdeep and Pristine for making this happen. I am really enjoying this series and learning a lot of valuable tricks about financial modeling.
If you like this series, say thanks to Paramdeep. I am sure he can take any amount of appreciation without choking.
Pristine is an awesome training institute for CFA, PRIMA, GARP etc. They have trained folks at HSBC, BoA etc. Chandoo.org is partnering with Pristine to bring an excel financial modeling online training program for you.
37 Responses to “Pie of a Pie of a Pie chart [Good or Bad?]”
If I could have the same quality of graphics and illustration in Office Apps, I would certainly use it.
If I could have the same quality of graphics in Office Apps (Excel, PPT) I would certainly use it.
Chandoo,
First, let me say I love your blog. I like this post, and I think that technically (in terms of readability of data) your argument is correct. The bar of bars, and the table, are much better for readability and accuracy, and as you say would be much easier to produce.
But these points ignore the context of the chart. If the chart was part of a scientific paper, your solution would be a valid one. The context in this case is an illustrated atlas of wildlife. A companion graphic to go with written text. The importance of aesthetic goes up over readability and accuracy. Much of the data and points (I assume) will be covered in the text.
There's always a pure technical tufte-esque argument. But I sometimes think it ignores the value of aesthetics. (Which I admit are quite subjective)
Great post though. Thanks.
The Treemap makes the scope of the data much clearer! The 3D pie chart depiction is deceptive.
This reminds me of the videos ive seen on the internet where it compares the relative sizes of the earth with the larger planets, then the sun, then other stars in the galaxy. Eventually there is an image showing the largest star in the sky with a little pixel representing the sun.
My point is if you varied the size of the charts it would help convey the message. The first chart (salt vs fresh) would be the biggest and the rest would be arranged in descending order. I feel this would be more accurate.
It may be helpful to consider the advice of Steven Few and Edward Tufte regarding pie charts in general. To summarize, they are seldom the most useful way to present data. Here's Few's thoughtful piece on the subject.
http://www.perceptualedge.com/articles/08-21-07.pdf
Try putting the percentages on the bar charts instead of actual amounts. Lakewater would be .013 % instead of 52.
That is very good pie chart example.
Please send example file if it is possible.
It will work , even though colors may be confusing , it can be labeled well . Also it can be called as the drilled chart , as it drills in information further , like the first chart may show business in a region , second may drill into a particular region , thrid may further drill into wat products are there in that region . It works well for me , i would more vote for the 2 nd option .
Overall all this site is awesome ,
p.s : just like me
The risk with pie of a pie of a pie chart is that Jon may have a seizure by looking at it. Also, it isn't easy to read. 😉
I dunno. The only thing worse than a pie chart is a cascading series of pie charts. I don't even think they really lend themselves to this sort of thing. It just becomes a big hide-the-ball game with your viewer.
Those goofy connectors between the pies are pure chart junk. I can't really tell if the second chart has 2 series or 3 - because the connector is a different color than the 2 labeled slices. Despite that, even whereas the drill down kind of works, still the individual components suffer from the same old weaknesses that 3d pie charts have.
Use a large bar chart as your "cover story", and fill in the sub points with smaller bar charts - or even go grab the Fabrice SFE project for extra butter. Use page orientation, color, and some text styles to guide your audience through the drill downs.
FWIW, if you check out the guy's site, you can find several other truly mortifying charts:
http://www.andrewdavies.com.au/index.html
The methane emissions one is particularly heinous. Although, I'm kind of debating what I think about the 'Glacier Changes" chart. I'd kind of like to see the data on that to see how it would look in a more traditional horizon chart.
Thank you, that was scary. I don't understand the "Glacier changes" Chart at all...
Its a very nice way to represent the data, especially when we have sets and sub-sets within the data.
I like these!
Except for the fact that they aren't dynamic and hence must be setup manually each time
It would also be nice if they could be interrogated as in select a different segment and the new data falls out automagically, but then none of the standard Excel charts do that either.
I'd like it better if the bars were stacked. How about this idea (I hope I can convey it in words):
First bar is vertical and stacked.
Second bar is horizontal, stacked horizontally and the same proportion had it been on the first bar.
Third bar is vertical, stacked vertically and the same proportion had it been on the second bar.
Then it would really look like you are zooming on the chart, like the Powers of Ten video, or maybe like the golden ration spiral.
These looks shunting but setting up for each step makes kicks them out. However if these can be arranged automatically by native excel or by VBA, these will be the part of my "Archery"
I agree with Chandoo's Suggestion about the Bar Graph which represents data in a very appropriate manner. Even I prefer doing the same. I seldom use Pie Chart unless required.
That's a real nice example of a missleading infographic. But to be honest, I think chandoos suggestion is not much better!
Why are pie charts bad? I think because they don't show the real size-relations. The biggest pie in that example ist 300k big. The 2nd one has only the size of 10k, about 3% of the first one. Niether the pies nor the bars show the real sizes. I jnow, it's hard to show the sizes because the values of the second and the third pie are so small. But that's what visualization are about - showing relations to allow the reader to see the real sizes!
So how to show the real figures?
First possibility is o use a 1:1 scaling. Well then, you need a very big screen to show also after a 90° rotation, wihich I would prefer because it's a structural comparison and not a timeline. Maybe that solution is not the perfect way.
The other chance you have is to zoom in but to really show that you zoom in! http://www.pro-chart.de/images/Water_Fall.png maybe gives you a first impression what i mean. (i was a quick try, done in 10 minutes)
The next way is, maybe to fold the bars like in the financial report 2011 of the Post of Switzerland page 22. That chart is based on an excel chart. Maybe can explain you how to do it 😉
Financial Statement: http://www.post.ch/en/post-startseite/post-berichterstattung/post-berichterstattung-service/post-berichterstattung-downloads/post-gb-2011-finanzbericht.pdf
page 22: http://www.pro-chart.de/images/FS_Schweizer_Post.png
A way that is not so very common is to divide the bars in a lot of single datapoints. So maybe the 390k bar then consists of about 5,000 single datapoint. That's not possible - it is! Have a look:
http://www.pro-chart.de/images/Dotted_WF.png
It's pure excel!
Now one single point ist 0,2% of the whole (in the example above). Add more datapoints and you can visulize the very big and the very small numbers!
Wish you a lot of fun - visualizing with excel can be very powerful!
Joerg
...if you would like to know how these charts work, just send an email to J.Decker@pro-chart.de
Hey Joerg,
I don't dig so much the dotted waterfall thing. But this is kind of awesome:
http://www.pro-chart.de/images/FS_Schweizer_Post.png
Can you help me on the bar of bar graph? Would it be possible to create that from pivot table? Can you show me how to create the bar of bar graph?
do nothing but say "Awesome!"
You are a Rock star.....This seemed an answer as if someone was reading my mind and just had the solution to my questions on what I exactly was looking for .....What a Fab !!
can u explian me step by step
Can anyone please explain how to make this chart please.
Do you mean the pie of a pie chart or the folded bar chart?
Joery PIE OF PIE Chart please
Can someone please explain how to make PIE OF PIE Chart.
@Mandeep
The last line of the post is:
PS: If you want to know to create this pie of pie of pie chart in excel, see here.
Due to forum migration, link is now:
http://chandoo.org/forum/threads/multiple-pie-chart.7343/
Hi... i love these charts.... can any one show me how to draw these charts in excel 2010
@Vamshi
The very last line of the post refers you to:
PS: If you want to know to create this pie of pie of pie chart in excel, see here. http://chandoo.org/forums/topic/multiple-pie-cahrt
Where is the attachment....it used to be there...i have seen this before but now i am not able to find...
See this:
http://img.chandoo.org/playground/WaterDistribution-chandoo.xlsx
And this:
http://chandoo.org/forum/threads/how-do-you-create-this-chart.9743/
Normally I don't learn post on blogs, however I would like to
say that this write-up very compelled me to try and do so!
Your writing style has been amazed me. Thank you,
quite great article.
This is very impressive, I would like to learn how to build this for myself. I have tried for some time now, is there a step by step process on how to create these waterfall pie of pie charts?
I am novice to excel and use it very seldom. But your blog contains to the point information one needs to get going.
I was searching for a trick to do a Pie chart drill down - for example the first pie chart shows how the prices are distributed between perishable and non-perishable items.
Now if we want to know how the perishable items are distributed - one can click the segment and it will draw another pie chart with distribution of all different perishable items (milk,meat,fruit,veg etc)
So do you have any such trick?
Regards,
electrojit
I like the look of your pie of pie of pie chart, although I understand that the relative size of each pie does not represent the actual percentages.