Introduction to

Crystal Ball Simulations

Session 9
UCONN OPIM 5270
Acuna / Tschiegg
Wilkins / Van Dusen

Session 2 Goals

Understand why risk must be analyzed

Know pros / cons for three ways to analyze risk
Identify random variables in models
Know the four steps of a simulation process
Generate random numbers with Crystal Ball
Use the four steps of a simulation process
Explain how Crystal Ball supports Proj. Mgmt.

Fall 2012

Dealing with Randomness

Fall 2012

Most real-world business situations today

are probabilistic, but the decision models
used to deal with them are deterministic.
How to deal with randomness?

Ignore it

Simplify problem to make it analytically

tractable, get solution, then ignore real-life
complications

Find a way to obtain an approximate solution to

real-world problems

Monte Carlo Simulation

Monte Carlo simulation is a method by which

approximate solutions are obtained to realistic
(and therefore complicated) problems

This is in contrast to analytical methods, which

obtain exact solutions to highly stylized problems

Tradeoff between rigor and relevance

Fall 2012

Introduction to Simulation

What is this?
Y = f(X1, X2, , Xk)

Often, the values for one or more "input" cells

are unknown or uncertain

This creates uncertainty about the value of the

"output" cell

Simulation can be used to analyze these types

of models

Fall 2012

Random Variables & Risk

A random variable is any variable whose value

cannot be predicted or set with certainty.

Many input cells in spreadsheet models are

actually random variables. For example:
the future cost of raw materials
future interest rates
future number of employees in a firm
expected product demand

Decisions made using uncertain information often

involve risk. What risks?

Fall 2012

Why Analyze Risk?

Using expected values for uncertain cells tells us

nothing about the variability of the performance
measure.

Suppose an $1,000 investment is expected to return

$2,000 in two years. Would you invest if...

the outcomes could range from $1,060 to $4,000?

the outcomes could range from $0 to $2,100?

Alternatives with the same expected value may

involve very different levels of risk.

Fall 2012

Methods of Risk Analysis

Best-Case/Worst-Case Analysis

What-if Analysis

Simulation

Fall 2012

Best-Case/Worst-Case Analysis

Best case - plug in the most optimistic values for each

of the uncertain cells.

Worst case - plug in the most pessimistic values for

each of the uncertain cells.

This is easy to do and bounds the outcomes, but tells

us nothing about the distribution of possible outcomes
within the best and worst-case limits.

Other problems or benefits?

Fall 2012

Possible Performance Measure

Distributions Within a Range

worst case

best case

worst case

best case

worst case

best case

worst case

best case

Fall 2012

10

What-If Analysis
Plug in different values for the uncertain cells and see
what happens.

Benefits:

This is easy to do with spreadsheets

Other?

Fall 2012

Problems:

Values may be chosen in a biased way.

Hundreds or thousands of scenarios may be required to

generate a representative distribution.

Does not supply the tangible evidence (facts and figures)

needed to justify decisions to management.
11

Simulation

Values for uncertain cells are selected

randomly (and in an unbiased manner).

The computer generates hundreds (or

thousands) of scenarios.

We analyze the scenario results to better

understand the behavior of the performance
measure.

Allows decisions based on solid empirical

evidence.

Fall 2012

12

Simulation

Proper risk assessment requires simulation.

Simulation is a 4 step process:
1) Identify the uncertain cells in the model.

2) Implement appropriate Random Number

Generators (RNGs) for each uncertain cell.
3) Replicate the model n times, and record the
value of the bottom-line performance measure.
4) Analyze the sample values collected on the
performance measure.
Fall 2012

13

Random Number Generators

A Random Number Generator is a

mathematical function that randomly
generates (returns) a value from a
particular probability distribution.

We can implement Random Number

Generators for uncertain cells to allow us to
sample from the distribution of values
expected for different cells.

Fall 2012

14

How Random Number

Generators Work

The RAND( ) function returns uniformly distributed

random numbers between 0.0 and 0.9999999.

Suppose we want to simulate the act of tossing a fair

coin.

Let 1 represent heads and 2 represent tails.

Consider the following RNG:

=IF(RAND( )<0.5,1,2)

Fall 2012

15

Generating Random Numbers

With Crystal Ball
Crystal Ball provides two different ways for creating
Random Number Generators in spreadsheets
Crystal Ball functions
Used in formulas like any other Excel function
Require CB to be installed on the machine displaying the
spreadsheet & do not support all CB functionality
The Distribution Gallery
Display a number (not a formula) in a cell but generates
random numbers for that cell when simulating the model
Does not require CB to be installed on the machine to
display the spreadsheet & supports all CB functionality
Fall 2012

16

Using the Distribution Gallery

Click Define
Assumption icon

Fall 2012

Select distribution

Specify parameters

17

Examples of Discrete
Probability Distributions

Fall 2012

18

Examples of Continuous
Probability Distributions

Fall 2012

19

What does Crystal Ball look like

in Excel? (Office 2007/2010)
Crystal Ball Toolbar

Define Menu

Analyze Menu

Run Menu
Fall 2012

20

How does Crystal Ball work?

1. Determine which model inputs
are uncertain and define a
probability distribution.
2. Identify which forecasts you want
to analyze/measure
(e.g., NPV, Sigma level, process efficiency)

3. Run Simulation
4. Analyze Results
5. Generate Report
Fall 2012

21

1. Define your Distributions

The first step to using Crystal Ball is to determine which
model inputs are uncertain. Which values are estimates?
Which are averages?
Once you have identified
these, you use your knowledge
of the uncertainty around the
input to create a probability
distribution for that cell (what
Crystal Ball calls an
assumption). Crystal Ball lets
you define these distributions
using the Distribution Gallery
Fall 2012

22

Assumption Dialog

Enter variety of
parameters to define
distributions

Can fit distributions to raw

data

Can cell reference all

fields

Can correlate pairs of

assumptions

Marker lines

Fall 2012

23

2. Identify Your Forecasts

The next step is to

identify a forecast. A
forecast is a formula
cell that you want to
measure and analyze.
In this model, you select
the Net Profit (cell C23).
Fall 2012

24

3. Run Simulation

Crystal Ball uses Monte Carlo simulation to randomly generate

thousands of what-if scenarios
Each scenario is then captured and presented in a frequency
chart (Forecast Chart)
Number of data
points displayed in
the chart

Number of
simulation trials
performed

Parts within the spec

limits are shown in
blue, parts outside
spec limits are shown
red

Display range
Fall 2012

Certainty (probability) that the forecast

will reach $2,812,558

25

4. Analyze Results
Whats responsible for most of the variation in the forecast?
The sensitivity chart shows the influence each assumption
cell has on the forecast.

Fall 2012

26

5. Generate Reports
Reports

Extract Data

Select a pre-defined report or create your

own custom report. Reports now include
new statistics and more control over data
and charts.

You can extract data from both forecasts and

assumptions and extract multiple types of
data.

Fall 2012

27

Build a Model for Simulation

Go to Crystal Ball in Excel

Fall 2012

28

Relevance to Project Management?

With simulation software (like Crystal Ball)
you can account for, and manage against
the uncertainty of:

Fall 2012

Time (how long the project may take)

Money (how much the project may cost)
Scope (variance from specification)
29

Additional Uses of Simulation

Simulation is used to describe the behavior of

a bottom-line performance measure when
values of one or more input variables are
uncertain.

Often, some input variables are under the

decision makers control.

Simulation (Crystal Ball) can also assist in

finding the optimal values of the controllable
input variables. (Simulation Optimization)

Fall 2012

30