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    Sensitivity Analysis: Modeling Risk and Uncertainty

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    Sam Sam
    Sensitivity analysis is used to analyze the risk of a capital expenditure project by calculating the project's net present value (NPV) under different assumptions. This helps identify which variables the NPV is most sensitive to, known as critical variables, and how much they would need to change to make the project unviable. Management should focus on controlling variables with high sensitivity to minimize risk and ensure the project's NPV remains positive. An example is provided to demonstrate calculating the sensitivity of key variables like sales volume, selling price, and costs.

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    Sensitivity Analysis: Modeling Risk and Uncertainty

    Uploaded by

    Sam Sam
    42 views10 pages
    Sensitivity analysis is used to analyze the risk of a capital expenditure project by calculating the project's net present value (NPV) under different assumptions. This helps identify which variables the NPV is most sensitive to, known as critical variables, and how much they would need to change to make the project unviable. Management should focus on controlling variables with high sensitivity to minimize risk and ensure the project's NPV remains positive. An example is provided to demonstrate calculating the sensitivity of key variables like sales volume, selling price, and costs.

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    Sensitivity Analysis

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    Sensitivity analysis is used to analyze the risk of a capital expenditure project by calculating the project's net present value (NPV) under different assumptions. This helps identify which variables the NPV is most sensitive to, known as critical variables, and how much they would need to change to make the project unviable. Management should focus on controlling variables with high sensitivity to minimize risk and ensure the project's NPV remains positive. An example is provided to demonstrate calculating the sensitivity of key variables like sales volume, selling price, and costs.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    42 views10 pages

    Sensitivity Analysis: Modeling Risk and Uncertainty

    Uploaded by

    Sam Sam
    Sensitivity analysis is used to analyze the risk of a capital expenditure project by calculating the project's net present value (NPV) under different assumptions. This helps identify which variables the NPV is most sensitive to, known as critical variables, and how much they would need to change to make the project unviable. Management should focus on controlling variables with high sensitivity to minimize risk and ensure the project's NPV remains positive. An example is provided to demonstrate calculating the sensitivity of key variables like sales volume, selling price, and costs.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 10

    Modeling Risk

    SENSITIVITY ANALYSIS and


    uncertainty
    SENSITIVITY
    SENSITIVITY
    SENSITIVITY ANALYSIS

    Sensitivity analysis is one method of


    analysing the risk surrounding a capital
    expenditure project and enables an
    assessment to be made of how responsive the
    project's NPV is to changes in the variables
    that are used to calculate that NPV
    NPV DEPENDENT VARIABLES

    Selling Price

    NPV Variable
    Sales Volume

    Cost of capital

    Initial Cost

    Operating Cost

    Cash Flow
    SENSITIVITY ANALYSIS

     The basic approach of sensitivity analysis is to calculate the


    project's NPV under alternative assumptions to determine
    how sensitive it is to changing conditions.
     An indication is thus provided of those variables to which the
    NPV is most sensitive (critical variables) and the extent to
    which those variables may change before the investment
    results in a negative NPV
     Sensitivity analysis therefore provides an indication of why a
    project might fail.
     Management should review critical variables to assess
    whether or not there is a strong possibility of events occurring
    which will lead to a negative NPV.
    SENSITIVITY ANALYSIS

      Management should also pay particular attention to


    controlling those variables to which the NPV is particularly
    sensitive, once the decision has been taken to accept the
    investment.
     A simple approach to deciding which variables the NPV is
    particularly sensitive to is to calculate the sensitivity of each
    variable:
     %
     The lower the percentage, the more sensitive is NPV to that
    project variable as the variable would need to change by a
    smaller amount to make the project non-viable.
    EXAMPLE: SENSITIVITY ANALYSIS

     Kenney Co is considering a project with the following cash


    flows.
     cash flows arise from selling 650,000 units at $10 per unit.
    Kenney Co has a cost of capital of 8%.
    EXAMPLE: SENSITIVITY ANALYSIS
    EXAMPLE: SENSITIVITY ANALYSIS

      The project has a positive NPV and would appear to be


    worthwhile. The sensitivity of each project variable is as
    follows.
     A) Initial Investment = × 100 = 14.6%
     B) Sales Volume = × 100 = 12.8%
     c) selling Price = × 100 = 8.8%
     d) Variable cost = × 100 = 28.7%
     The elements to which the NPV appears to be most sensitive
    are the selling price followed by the sales volume.
    Management should thus pay particular attention to these
    factors so that they can be carefully monitored.

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