## Vertex42 The Excel Nexus

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## Spreadsheet Analysis of Product Demand and Supply Conditions

Spreadsheet analysis is an appropriate means for studying the demand and supply effects of possible changes in various exogenous and endogenous variables. Endogenous variables include all important demand- and supply-related factors that are within the control of the firm. Examples include product pricing, advertising, product design, and so on. Exogenous variables consist of all significant demand- and supply-related influences that are beyond the control of the firm. Examples include competitor pricing, competitor advertising, weather, general economic conditions, and related factors. In comparative statics analysis, the marginal influence on demand and supply of a change in any one factor can be isolated and studied in depth. The advantage of this approach is that causal relationships can be identified and responded to, if appropriate. The disadvantage of this marginal approach is that it becomes rather tedious to investigate the marginal effects of a wide range of demand and...

## Set Up A Spreadsheet To Illustrate The Effects Of Changing Economic Assumptions On The Demand For Sunbest Orange Juice.

Set up a table or spreadsheet to illustrate the effects of changing economic assumptions on the demand for Sunbest orange juice. Use the demand function to calculate demand based on three different underlying assumptions concerning changes in the operating environment. First, assume that all demand factors change in unison from levels indicated in the Optimistic Scenario 1 to the levels indicated in Pessimistic Scenario 10. Second, fix all demand factors except the price of Sunbest at Scenario 6 levels, and then calculate the quantity demanded at each scenario price level. Finally, fix all demand factors except temperature at Scenario 6 levels, and then calculate demand at each scenario temperature level. B. Set up a table or spreadsheet to illustrate the effects of changing economic assumptions on the supply of Sunbest orange juice. Use the supply function to calculate supply based on three different underlying assumptions concerning changes in the operating environment. First,...

## Using spreadsheet packages

Standard spreadsheet packages such as Excel can perform multiple regression analysis and are sufficient for most routine tasks. A regression equation can be calculated via menus and dialogue boxes and no knowledge of the formulae is required. However, when problems such as autocorrelation (see below) are present, specialised packages such as TSP, Microfit or Stata are much easier to use and provide more comprehensive results.

## Using a Spreadsheet

People use electronic spreadsheets to manage numbers quickly and easily. Formulas may be used to add, subtract, multiply, and divide the numbers in the spreadsheet. If you make a change to one number, the totals are recalculated automatically for you. To understand how to use a spreadsheet, read the following descriptions of several spreadsheet calculations A spreadsheet is an electronic worksheet. It is made up of numbered cells that form rows and columns. Each column (vertical) is assigned a letter or number. Each row (horizontal) is assigned a number. Each point where a column and row intersect is called a cell. The cell's position on the spreadsheet is labeled according to its corresponding column and row-Column A, Row 1 (A10) Column B, Row 2 (B2) and so on. See the diagram below. 1 Spreadsheets use standard formulas to calculate numbers. To create a formula, highlight the cell you want the results in. Type an equal sign ( ) and then build the formula, step by step. If you type...

## Selftest Problems And Solutions

Set up a table or spreadsheet to illustrate the effect of price (P), on the quantity supplied (QS), quantity demanded (QD), and the resulting surplus (+) or shortage (-) as represented by the difference between the quantity demanded and the quantity supplied at various price levels. Calculate the value for each respective variable based on a range for P from 1.00 to 3.50 in increments of 10tf (i.e., 1.00, 1.10, 1.20, . . . 3.50). A. A table or spreadsheet that illustrates the effect of price (P) on the quantity supplied (QS), quantity demanded (QD), and the resulting surplus (+) or shortage (-) as represented by the difference between the quantity demanded and the quantity supplied at various price levels is as follows

## Basic Economic Relations

Until recently, however, it was simply impractical to compare the relative pluses and minuses of a large number of managerial decisions under a wide variety of operating conditions. For many large and small organizations, economic optimization remained an elusive goal. It is easy to understand why early users of personal computers were delighted when they learned how easy it was to enter and manipulate operating information within spreadsheets. Spreadsheets were a pivotal innovation because they put the tools for insightful demand, cost, and profit analysis at the fingertips of managers and other decision makers. Today's low-cost but powerful PCs and user-friendly software make it possible to efficiently analyze company-specific data and broader industry and macroeconomic information from the Internet. It has never been easier nor more vital for managers to consider the implications of various managerial decisions under an assortment of operating scenarios.

## Using Economic Analysis to Predict the Future

One of the largest single influences on the level of interest rates is inflation. There are a number of sites that report inflation over time. Go to ftp ftp.bls.gov pub special.requests cpi cpiai.txt and review the data available. Note that the last columns report various averages. Move this data into a spreadsheet using the method discussed in the Web exploration at the end of Chapter 1. What has the average rate of inflation been since 1950, 1960, 1970, 1980, and 1990 What year had the lowest level of inflation What year had the highest level of inflation

## Compound Interest Factors for Discrete Compounding

Compound interest factors are formulas that define mathematical equivalence for specific common cash flow patterns. The compound interest factors permit cash flow-analysis to be done more conveniently because tables or spreadsheet functions can be used instead of complicated formulas. This section presents compound interest factors for four discrete cash flow- patterns that are commonly used to model the timing of receipts and disbursements in engineering economic analysis. The four patterns are

## Appendix 5A Tests for Multiple IRRs

Where a project is not simple, we go to the second test. The second test consists of making a graph plotting present worth against interest rate. Points at which the present worth crosses or just touches the interest-rate axis (i.e., where present worth 0) are IRRs. (We assume that there is at least one IRR.) If there is more than one such point, we know that there is more than one IRR. A convenient way to produce such a graph is using a spreadsheet. See Example 5A.1. Table 5A.1 Spreadsheet Cells Used to Construct Figure 5A.1 Table 5A.1 Spreadsheet Cells Used to Construct Figure 5A.1

## End of Main Chapter Problems

Q 3.32 Your firm just finished the year, in which it had cash earnings of 400 (thousand dollars). You forecast your firm to have a quick growth phase for 5 years, in which it grows at a rate of 40 per annum. Your firm's growth then slows down to 20 per annum for the next 5 years (i.e., from year 5 to year 6, the growth rate is 20 ). Finally, beginning in year 11, you expect the firm to settle into its long-term growth rate of 2 per annum. You also expect your cost of capital to be 15 over the first 5 years, then 10 over the next 5 years, and 8 thereafter. What do you think your firm is worth today (Note this problem is easiest to work in a computer spreadsheet.)

## Assessment and Activities

Using a Spreadsheet Use your personal buying decisions to create a spreadsheet and graph showing how 5. Highlight the three columns on the spreadsheet, then click on Chart Wizard or a similar icon, or click on Insert and then Chart. 7. Follow the spreadsheet directions to title your graph.

## Gross Domestic Product 19662000

The following spreadsheet shows weekly demand data and regression model estimation results for Super Detergent in these 30 regional markets The following spreadsheet shows weekly demand data and regression model estimation results for Super Detergent in these 30 regional markets

## Limitations of Linear Cost VolumeProfit Analysis

Linear cost-volume-profit analysis has a weakness in what it implies about sales possibilities for the firm. Linear cost-volume-profit charts are based on constant selling prices. To study profit possibilities with different prices, a whole series of charts is necessary, with one chart for each price. With sophisticated spreadsheet software, the creation of a wide variety of cost-volume-profit charts is relatively easy. Using such software, profit possibilities for different pricing strategies can be quickly determined. Alternatively, nonlinear cost-volume-profit analysis can be used to show the effects of changing prices.

## When Capital or Operating Costs Are Non Monotonic

As the number of years increases, this approach for calculating the EAC becomes more difficult, especially since in this case the operating costs are neither a standard annuity nor an arithmetic gradient. An alternative is to calculate the present worths of the operating costs for each year. The EAC of the operating costs can be found by applying the capital recovery factor to the sum of the present worths for the particular service period considered. This approach is particularly handy when using spreadsheets. The equivalent annual cost of using the defender one more year is S3288. This is more than the yearly cost of installing and using the challenger over its economic life. Since the operating costs are not smoothly increasing, we need to see if there is a longer life for the defender for which its costs are lower than for the challenger. This can be done with a spreadsheet, as shown in Table 7.6.

## Additional Pedagogical Features

I A spreadsheet icon like the one shown here indicates where Examples or Problems involve spreadsheets, which are available on the Instructor's Resource CD-ROM. The use of computers by engineers is now as commonplace as the use of slide rules was 30 years ago. Students using this book will likely be yen- familiar with spreadsheet software. Consequently, such knowledge is assumed rather than taught in this book. The spreadsheet Examples and Problems are presented in such a manner that they can be done using any popular spreadsheet program, such as Excel, Lotus 1-2-3, or Quattro Pro. I Tables of interest factors are provided in Appendix A, Appendix B, and Appendix C. I Answers to Selected Problems are provided in Appendix D.

## Regression Statistics

Published by MINITAB, Inc., and SPSS Advanced Statistics, published by SPSS, Inc. Both are inexpensive, easy to learn, and offer a wealth of powerful techniques for data analysis and regression model estimation. Less comprehensive statistical software that run along with Microsoft Excel and other spreadsheet programs can also be useful, especially when detailed statistical analysis is unnecessary. This section focuses on the interpretation of regression output.

## What type of forecasting system is desirable

Often forecasting is performed in different sections of a policy-making institution, each with responsibilities for specific parts of the forecast horizon. In particular, it is very common to have two sections. One section concentrates upon modeling of the whole system with a core model, adopting an horizon that is longer than six months, while the other focuses upon the initial six months. This latter group generally employs either an indicator or spreadsheet model, but also uses a good deal of judgment in forming the short-term forecast. The knowledge of sector specialists is relied upon quite heavily in this regard. Models may be involved but they are mostly statistical in nature, although economic ideas may guide and inform the choices. It is rare for much economic structure to be formally imposed at this level, and the methods do not lend themselves to producing a consistent statement about the evolution of the complete system. Whilst it is certainly possible to preserve national...

## The Art of Business Valuation

The advent of the computerized spreadsheet has exacerbated this problem, creating the illusion of extensive and thoughtful analysis, even for the most haphazard of efforts. Typically, investors place a great deal of importance on the output, even though they pay little attention to the assumptions. Garbage in, garbage out is an apt description of the process.

## The Reserve Bank of Australia The process

The RBA constructs forecasts using several of the approaches described earlier and these are presented to internal staff meetings in the lead-up to each Board meeting. A small core macroeconometric model is used to produce a set of no-policy change forecasts, adjusted in light of special anticipated events using intercept corrections. For example, inflation forecasts for the year 2000 have to recognize the impact of the pending introduction of a Goods and Services Tax. The model-based forecasts are then compared to those from the groups responsible for producing separate forecasts of real and nominal variables. These groups use a variety of spreadsheet or indicator models, as well as incorporating their own judgment and survey data. For example, survey data on expected future capital expenditure by the private sector in Australia have proved to be quite accurate predictors of investment. There is often conflict between the projections of the spreadsheet and core modeling groups and...

## What did Bear Stearns get out of this deal

After I left Ace's office, I went downstairs to the computer store and bought myself a Macintosh, which I set up on my dining room table. I constructed the spreadsheets for a transaction opportunity I saw would be feasible over the next few days and then faxed the sheets to a Fortune 50 company for whom I had done similar deals

## Is Monopoly Always

Nevertheless, it is important to recognize that monopoly is not always as socially harmful as sometimes indicated. In the case of Microsoft Corp., for example, the genius of Bill Gates and a multitude of research associates has created a dynamic computer software juggernaut. The tremendous stockholder value created through their efforts, including billions of dollars in personal wealth for Gates and his associates, can be viewed only as a partial index of their contribution to society in general. Other similar examples include the DeKalb Corporation (hybrid seeds), Kellogg Company (ready-to-eat cereal), Lotus Corporation (spreadsheet software), and the Reserve Fund (money market mutual funds), among others. In instances such as these, monopoly profits are the just rewards flowing from truly important contributions of unique firms and individuals.

## The Incentive to Differentiate

The primary incentive for sellers to differentiate is the reduced substitutability between products as differentiated products become imperfect substitutes for each other. For example, consider two spreadsheet programs with a similar appearance and performance such that the two products are perfectly substitutable. If one of the two companies changes the look and feel of its program, the two products are differentiated and some consumers may choose a program because of the new difference. Therefore, the two products are no longer perfect substitutes. With reduced substitutability between products, retaliatory price-cutting does not result in a complete loss of one's market share. Product differentiation thus gives a firm a certain power within its own market. Such a market is called a monopolistically competitive market.

## Numerical Illustration

1,854 billion ( 1.8 billion plus 54 million). This amount of capital produces a GNP of 618 million ( 1,854 billion divided by 3). The population also grows by 2 percent, and so stands at 1.02 million. Per capita income is equal to 606 ( 618 million divided by 1.02 million). Per capita income has increased by 1 percent (in comparison with 600), and will increase each year through the decade. Actually, the growth rate will rise gradually over time, reaching more than 2 percent per annum toward the end of the decade as household incomes rise further above the 300 threshold of basic needs. If you use a spreadsheet to repeat the calculations for ten years rather than one year, the GNP per person at the end of the decade is 687, up 15 percent during the decade.

## A2 Problem Definition

It's probably easiest to use a spreadsheet to develop cash flow sequences for the three options. The two options in which only a single machine is bought at time zero are pretty straightforward. The one with a sequence of two small formers is a bit more complicated. One of us can do the two easy ones. The other can do the sequence. For each option we need to look at, say, nine outcomes three possible demand growth rates 5 , 10 , and 15 times three possible prices 3c, 3.5c, and 4c for selling excess capacity. That should be enough to show us what's happening. What part do you want to do

## Managerial Application 151

A fourth problem can relate to the timing of cash flows. Year-end accounting income statements seldom reflect exactly when revenues or expenses occur. Because of the time value of money, capital budgeting cash flows should be analyzed according to when they occur. A time line of daily cash flows would in theory be most accurate, but it is sometimes costly to construct and unwieldy to use. In the case of Gourmet Foods, it may be appropriate to measure incremental cash flows on a quarterly or monthly basis using an electronic spreadsheet. In other cases, it may be appropriate simply to assume that all cash flows occur at the end or midpoint of every year.

## Practice Problems

Throughout this section we have concentrated on linear models. An obvious question to ask is whether we can extend these to cover the case of non-linear relationships. Unfortunately, the associated mathematics gets hard very quickly, even for mildly non-linear problems. It is usually impossible to find an explicit formula for the solution of such difference equations. Under these circumstances, we fall back on the tried and trusted approach of actually calculating the first few values until we can identify its behaviour. A spreadsheet provides an ideal way of doing this, since the parameters in the model can be easily changed.

## Case Study

A Spreadsheet Approach to Finding the Economic Order Quantity A spreadsheet is a table of data that is organized in a logical framework similar to an accounting income statement or balance sheet. At first, this marriage of computers and accounting information might seem like a minor innovation. However, it is not. For example, with computerized spreadsheets it becomes possible to easily reflect the effects on revenue, cost, and profit of a slight change in demand conditions. Similarly, the effects on the profit-maximizing or breakeven activity levels can be easily determined. Various what if scenarios can also be tested to determine the optimal or profit-maximizing activity level under a wide variety of operating conditions. Thus, it becomes easy to quantify in dollar terms the pluses and minuses (revenues and costs) of alternate decisions. Each operating and planning decision can be easily evaluated in light of available alternatives. Through the use of spreadsheet formulas and...

## ExampleEXCEL

The most appropriate way of representing the results graphically is to use a bar chart. We would like the numbers in the first column of the spreadsheet to act as labels for the bars on the horizontal axis. Unfortunately, unless we tell Excel that we want to do this, it will actually produce two sets of bars on the same diagram, using the numbers in column A as heights for the first set of bars, and the numbers in column B as heights for the second set. This can be avoided by entering the values down the first column as text. This is done by first highlighting column A and then selecting Format Cells from the menu bar. We choose the Number tab, and click on Text and OK. We can now finally enter the values of 0, 1, 2, , 10 in the first column, together with the headings and numerical value of P0 in column 2 as shown in Figure 9.3. The remaining entries in column B are worked out using the difference equation Chart Wizard can now be used to plot this time path. We first highlight both...

## Sensitivity Analysis

In preparing a sensitivity plot, it is advisable to have the base case on a spreadsheet. Then one can determine the effect on profitability by varying the items in the study. One should be aware that variables, such as sales volume are reflected in operating expenses as raw material requirements, general overhead expenses, etc. Numerous scenarios may be prepared from the basic spreadsheet. A plot then may be developed from the spreadsheet results. A sensitivity analysis of the purchase of wire-line trucks and the resulting sales scenarios for a petroleum production application are found in Table 10.1 and Figure 10.5.

## Questions

Construct spreadsheets for calculating present worths of the three proposals. For each proposal, you need to calculate PWs for each of 5 , 10 , and 15 demand growth and SO.03, 0,035, and S0.04 selling price (nine combinations in all). Present the results in tabular and or graphical format to support your analysis. A portion of a sample spreadsheet layout is given in Table A.2. Table A.2 Portion of a Present Worth Spreadsheet Table A.2 Portion of a Present Worth Spreadsheet

## To The Student

What do you need to understand this book You do not need any specific background in finance. You do need to be thoroughly comfortable with arithmetic and generally comfortable with algebra. You do need mathematical aptitude, but you do not need to know advanced mathematical constructs, such as calculus. Knowledge of statistics would be very helpful, but the book will explain the relevant concepts when the need arises. You should own a S20 scientific calculator. A financial calculator is not necessary, though your instructor may like one. As to myself, I prefer that you learn how to operate a spreadsheet (such as Excel in Microsoft's Office or the free OpenCalc spreadsheet in OpenOffice). It is easier to work with information on a large screen with a 2,000 MHz processor than on a small 2-line display with a 2MHz processor. Because I have tried hard to keep the book self-contained and to explain everything from first principles, you should not need to go hunting for details in...

## Side Note

Real Options Real options are briefly covered in Chapter 12 in the text, but not in great detail. This web chapter shows how to use spreadsheets, time-series analysis, Monte Carlo simulation, and optimization to determine the value of a plant that can shut down and reopen (for a cost) as output prices fluctuate. Ethics This chapter is experimental and provocative. There is neither a particular set of must-cover topics nor a template on how to present this material. Your choices and views may differ from mine. However, I believe that ethical considerations are too important for them never to be raised. Capital Structure Event Studies This chapter describes the evidence (up-to-2003 ) of how the stock market reacts to the announcements of new debt offerings, new equity offerings, and dividend payments.

## Acknowledgements

The research described here still very much represents work in progress - currently under the aegis of a research fellowship awarded under the Goal Environmental Change Programme of the ESRC. The author is indebted to David Waxman who operationalised for 'Matlab' software (version 4.2c.1) the 'diversity optimisation' procedure developed by the author. Without David's invaluable input, the illustrative analysis described in the final section of this paper would have been prohibitively difficult to perform on a spreadsheet. Without implicating them in any way in the shortcomings, the author is also especially grateful for many thoughtful general comments on the manuscript by Chris Freeman, Keith Pavitt, Ed Steinmueller and Nick von Tunzelman and for discussions over the years on various specific issues arising in this study to colleagues at SPRU and further afield, especially David Fisk (on fuzzy logic and ignorance), Sylvan Katz (on complexity and power law relations), Gordon MacKerron...

## Selected References

Kemerer. 1996. Network Externalities in the Microcomputer Software An Econometric Analysis of the Spreadsheet Market. Management Science 42, 1627-1647. Gandal, N. 1994. Hedonic Price Indexes for Spreadsheets and an Empirical Test of the Network Externalities Hypothesis. Rand Journal of Economics 25 160-170.

## Figure

Spreadsheet and Statistical Software for the PC The personal computer revolution in business really got underway in the 1980s following the publication of powerful and easy-to-use spreadsheet software. Microsoft's Excel has blown away the original standard, Lotus 1-2-3, to make income statement and balance sheet analysis quick and easy. Recent versions incorporate a broad range of tools for analysis, including net present value, internal rate of return, linear programming, and regression. Such software also allows managers to analyze and display operating data using a wide variety of charting and graphing techniques. For basic statistical analysis, Excel features easy-to-use statistical capabilities like regression and correlation analysis.

## Software piracy

Givon, Mahajan, and Muller (1995) suggest a modeling approach to track legal and illegal diffusion of software in order to estimate the pirated adoptions over time and the percentage of legal adoptions due to the influence of pirates. Their study focused on two popular types of software (spreadsheets and word processors) in England. The major difficulty of such a study is that even if one has data on the number of microcomputers and the legal adoption of software, still one cannot assume that all microcomputer owners will either buy the two types of software or use pirated copies. For this reason, building a diffusion model was necessary. A monthly data of sales of PCs, legal sales of spreadsheets and word processors in England from 1987 to 1992 reveals that the ratio of pirates to buyers increased to six pirates for every buyer who has purchased the software. However, they demonstrate that during the same time the percentage of unit sales of buyers due to the influence of pirates has...

## Pl PFPiN

Although die compound amount factor and the present worth factor are relatively easy to calculate, some of the other factors discussed in this chapter are more complicated, and it is therefore desirable to have an easier way to determine their values. The compound interest factors are sometimes available as functions in calculators and spreadsheets, but often these functions are provided in an awkward format that makes them relatively difficult to use. They can, however, be fairly easily programmed in a calculator or spreadsheet.

## Correlation Analysis

Where of is the covariance between the forecast and actual series, and Uf and ux are the sample standard deviations of the forecast and actual series, respectively. Basic spreadsheet and statistical software readily provide these data, making the calculation of r a relatively simple task. Generally speaking, correlations between forecast and actual values in excess of 0.99 (99 percent) are highly desirable and indicate that the forecast model being considered constitutes an effective tool for analysis.

## Practice Problem

We conclude this section by describing the use of a computer package to solve optimization problems. Although a spreadsheet could be used to do this, by tabulating the values of a function, it cannot handle the associated mathematics. A symbolic computation system such as Maple, Matlab, Mathcad or Derive can not only sketch the graphs of functions, but also differentiate and solve algebraic equations. Consequently, it is possible to obtain the exact solution using one of these packages. In this book we have chosen to use Maple.

## Programming

Linear programming, or so-called solver PC software, can be used to figure out the best answer to an assortment of questions expressed in terms of functional relationships. In a fundamental sense, linear programming is a straightforward development from the more basic what if approach to problem solving. In a traditional what-if approach, one simply enters data or a change in input values in a computer spreadsheet and uses spreadsheet formulas and macros to calculate resulting output values. A prime advantage of the what if approach is that it allows managers to consider the cost, revenue, and profit implications of changes in a wide variety of operating conditions. An important limitation of the what if method is that it can become a tedious means of searching for the best answer to planning and operating decisions.

## Software

The software directs the computer to perform very specific tasks such as creating a financial spreadsheet statement model, preparing a slide presentation, or writing a document on a word processing program. Specific applications software include programs such as Microsoft's Word (word processing), PowerPoint (presentations), and Excel (financial spreadsheets).

## Discussions

Standard spreadsheet based database is used to keep track of the subject's profile, payment information and the history of participation. These data allow us to control samples of subjects as the need arise. A special checking account was created and all the subjects were paid by checks. In addition, a financial framework, internal to HP, was set up enabling the charging of experimental expenses to the proper accounts, since multiple business organizations are engaging in collaborative projects with the experimental economics program.

## Search this book

Differentiated products catering to different segments of consumers, multiple products are desired. These products may be produced by one producer. However, the costs associated with differentiation and customization may indicate a lack of scale economies. For application software such as word processing and spreadsheet programs, differentiation is desirable. Any artificial means to standardize such programs will be contrary to competition and consumer satisfaction. Again, economy of scale will not be the primary concern.

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