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Describe Sensitivity Analysis as a method of analysing risks

Describe Sensitivity Analysis as a method of analysing risks

Answers

• Since future is uncertain, you may like to know what will happen to the viability of the project when some variable like sales or investment deviates from its expected value ? ?what if?


• Vary one variable at a time holding the other variables constant

• Merits SA
– Shows how robust or vulnerable a project is to changes in values of the underlying variables
– Indicates where further work may be done. If the NPV is highly sensitive to changes in some factor, it may be worthwhile to explore how the variability of that critical factor may be contained
– It is intuitively a very appealing method as it articulates the concerns that project evaluators normally have

• Shortcomings of SA
– It merely shows what happens to NPV when there is a change in some variable without providing any idea of how likely that change will be
– Typically, in sensitivity analysis only one variable is changed as a time. In the real world, however variables tend to move together
– It is inherently a very subjective analysis. The same SA may lead one decision maker to accept the project while another may reject it

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Titany answered the question on November 15, 2021 at 11:29

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