Investing

Objective To develop an LP spreadsheet model that relates investment decisions to total

ending cash and to use Solver to find the strategy that maximizes ending cash and
invests no more than a given amount in any one investment.
WHERE DO THE NUMBERS COME FROM?
Theres no mystery here. Assuming that the terms of each investment are spelled out,
Barney-Jones knows exactly when money must be invested and what the amounts and
timing of returns will be. Of course, this isnt the case for many real-world investments,
such as money put into the stock market, where considerable uncertainty is involved.

Solution
The variables and constraints for this investment model are listed in Table 1. On the
surface, this problem looks very straightforward. We must decide how much to invest in
the available investments at the beginning of each year, and we can use only the cash
available. If you try modeling this problem without our help, however, you might have
some difficulty. It took us a few tries to get a nice model, one that is easy to read and
generalizes to other similar investment problems. By the way, the second constraint in
the table can be expressed in two ways. It can be expressed as shown, where the cash on
hand after investing is nonnegative, or it can be expressed as cash on hand at the
beginning of any year must be greater than or equal to cash invested that year. These
are equivalent. The one we choose is a matter of taste.
Table 1

DEVELOPING THE SPREADSHEET MODEL

The spreadsheet model for this investment problem appears in Figure 1. (See file
Investing.xlsx.) To set up this spreadsheet, follow these steps:
Figure 1

Step1: Inputs and range names. As usual, enter the given inputs in the blue ranges
and name the ranges indicated. Pay particular attention to the two blue tables. This is the
first model we have encountered where model development is affected significantly by
the way we enter the inputs, specifically, the information about the investments. We
suggest separating cash outflows from cash inflows, as shown in the two ranges B11:F14
and B19:F23. The top table indicates when we invest, where a 0 indicates no possible
investment, and a 1 indicates a dollar of investment. The bottom table then indicates the
amounts and timing of returns per dollar invested.
Step2: Investment amounts. Enter any trial values in the Dollars_invested range. This
range contains the changing cells. Also put a link to the maximum investment amount
per investment by entering the formula =$B$5 in cell B28 and copying it across.
Step3: Cash balances and flows. The key to the model is the section in rows 32 to 36.
For each year, we need to calculate the beginning cash held from the previous year, the
returns from investments that are due in that year, the investments made in that year,
and cash balance after investments. Begin by entering the initial cash in cell B32 with the
formula =B4
Moving across, calculate the return due in year 1 in cell C32 with the formula
=SUMPRODUCT(B19:F19,Dollars_invested)
Admittedly, no returns come due in year 1, but this formula can be copied down column
C for other years. Next, calculate the total amount invested in year 1 in cell D32 with the
formula
=SUMPRODUCT(B11:F11,Dollars_invested)
Now find the cash balance after investing in year 1 in cell E32 with the formula
=B32+C32-D32
The only other required formula is for the cash available at the beginning of year 2.
Because any cash not invested earns 3% interest, enter the formula =E32*(1+$B$6)

in cell B33. This formula, along with those in cells C32, D32, and E32, can now be copied
down. (The 0s in column G are a reminder of the nonnegativity constraint on cash
afterinvesting.)
Ending cash. The ending cash at the beginning of year 5 is the sum of the amount in
the money market and any returns that come due in year 5. Calculate this sum with the
formula =SUM(B36:C36)
in cell B38. (Note: Here is the type of error to watch out for. We originally failed to
calculate the return in cell C36 and mistakenly used the beginning cash in cell B36 as the
target cell. We realized the error when the optimal solution called for no money in
investment D, which is clearly an attractive investment. The lesson is that you can often
catch errors by looking at the plausibility of your optimal solution.)

Review of the Model

Take a careful look at this model and how it has been set up. There are undoubtedly
many alternative ways to model this problem, but the attractive feature of the model is
the way the tables of inflows and outflows in rows 11 to 14 and 19 to 23 allow us to copy
formulas for returns and investment amounts in columns C and D of rows 32 to 36. In
fact, this same model setup, with only minor modifications, works for any set of
investments, regardless of the timing of investments and their returns. This is a quality
you should strive for in your own spreadsheet models: generalizability.

USING SOLVER
To find the optimal investment strategy, fill in the main Solver dialog box as shown in
Figure 2, check the Assume Linear Model and Assume Non-Negative options, and
optimize. Note that the explicit nonnegativity constraint in Figure 2 is necessary, even if
the Assume Non-Negative option is checked. Again, this is because the Assume NonNegative option covers only the changing cells. If we want other output cells to be
nonnegative, we must add such constraints explicitly.

Figure 2

Discussion of the Results

The optimal solution appears in Figure 1. Lets follow the cash. The company spends all
its cash in year 1 on the two available investments, A and C ($64,286 in A, $35,714 in C).
A total of $75,000 in returns from these investments is available in year 2, and all of this

is invested in investment B. (The minus signs in cells E33 and B34 are due to roundoff
error. The values in these cells are very small negative numbers, but they are equal to 0
for all practical purposes.) At the beginning of year 3, a total of $101,786 is available
from investment A and B returns, and $75,000 of this invested in investment E. This
leaves $26,786 for the money market, which grows to $27,589 at the beginning of year
4. In addition, returns totaling $187,500 from investments B and E come due in year 4. Of
this total cash of $215,089, $75,000 is invested in investment D, and the rest, $140,089,
is put in the money market. The return from investment D, $142,500, plus the money
available from the money market, $144,292, equals the final cash in the target cell,
$286,792.