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A Financial Modeling Simulation Project
A Case Study in Return on Investment

My Client's Situation. Wanted: A System to Analyze ROI.

"Several potential resource acquisitions come our way each week. It would take a crew of several specialists many hours every week to do justice to the job of analyzing return on investment for each of these. So, we had to develop a system to do the job." -- John W, Manager of Investments Analysis, San Francisco

With over $600 million in annual sales, acquisition analysis is an important process that involves considerable risk and uncertainty. Yet, the company must be able to attempt projection to know what they can afford to pay today, which is 20-30 years before the investment begins to realize a return.

What we did. A Financial Simulation Model to Analyze ROI on Lease/Buy Decisions.

John and I developed a computerized simulation model, called the Acquisition Analysis System to analyze "lease/buy" considerations involving acquisitions.

Our simulation model lets management analyze potential acquisitions in terms of expected cash flows and ROI, given certain assumptions that we easily put into the model. We can adjust these parameters to fit any negotiation terms.

Thus, management can see in advance the possible effects of paying a certain amount per year to the seller at x% inflation rate over the next 30 years. But, if the seller prefers a lower fixed rate and higher compensation for inflation, we can plug that into the model and see results in seconds.

"It used to take someone several days to do this type of analysis. Now we can explore several alternate lease/buy decisions in an hour or so. With our interactive features, we can change any or all our assumptions at anytime." -- A.S., Special Projects Manager, San Francisco

Our simulation model covers 20+ variables, ranging from applicable tax rates to industry various indexes. Critical assumptions revolve around future values and the escalation rates of costs, lease, or sale prices. These rates are not single-value inputs. Rather, a range is required which specifies the low, high, and most likely values.

A run's output includes a cumulative probability distribution of the ROI. We also print a list, by period, for items such as after-tax profit, cash flows, net investment, and net present value. Our program analyzes all these items for both lease and buy cases.

The Results. Fast, Easy Lease/Buy Decisions.

The result is that my client's buyers now have only to place a call to headquarters with potential acquisition information. Proposed lease/buy data is immediately fed into the model. If the ROI looks good, the resource is either bought or leased, or further negotiated. Any subsequent changes can be quickly reported, and alternate simulations run.

"An unexpected advantage of using the model has been the identification of critical variables and their respective sensitivity to the overall analysis. Discovery of these critical factors has led us to initiate further studies in an attempt to more accurately predict their values." -- AS, Special Projects Manager, San Francisco

"Fast turnaround is important when conducting our negotiations because frequently we face a lot of competition for the same resource, and it's important when making an offer to know our limits -- what we can and can’t afford to pay... We've been pleased with the results of this approach. This simulation model gives us a more accurate means to forecast our revenue streams. And it serves as a good negotiating tool that allows us to come back quickly with some realistic answers on how our investments can be expected to work for us over the years." -- John W, Manager of Investments Analysis, San Francisco

Questions? Comments? Send me an email.

Best Regards,

Mike Hayden, Principal/Consultant
Your partner in streamlining business.

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(c) 2005 Mike Hayden
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