Monte Carlo: not just in Monaco

BVWireIssue #69-3
June 25, 2008

Bill Kennedy Ph.D., CPA/ABV (Anders Minkler & Diehl LLP in St. Louis) presented the “Use of Monte Carlo Simulation in Valuation and Litigation Support Engagements” at NACVA’s Fifteenth Annual Consultants’ Conference in Las Vegas in early June.  The use of a Monte Carlo simulator can quickly and accurately help an appraiser determine value, especially when there are inputs to a valuation model that could have a range of possible values.  This is a great tool to use when testing a wide range of what-ifs and when tracking the results is important.

Dr. Kennedy showed how to set up a base spreadsheet that includes the various inputs—then by using ORACLE’s Crystal Ball Monte Carlo simulator (an add-in to Microsoft Excel), he demonstrated how to set ranges on those inputs that were variable.  The Monte Carlo simulator then randomly selects a value for each input variable based on the user’s criteria and runs the model hundreds or thousands of times.  The result is a graph (see below for a representative graph from the ORACLE website) that shows the occurrence of each result of the calculation—with the “mean of the distribution representing the most likely outcome of the forecast, eliminating risks inherent in a single static forecast.”

              Crystal Ball

Dr. Kennedy also shared several business valuation-specific scenarios where the Monte Carlo simulator would be useful, including:

  • Sensitivity analysis of changing forecast assumptions when using a DCF model in a valuation
  • Sales forecasting, product demand forecasting, cost estimating and other financial forecasting
  • Lost profits calculations when accounting for the risks of success and failure
  • Refining calculations of a lost royalty income based on forecasted sales
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