Chapter 6 - Investment Appraisal Under Uncertainty

Question 0

Sensitivity analysis

Answer 0

The maximum possible change is often expressed as a percentage:

Sensitivity margin = NPV/ Present value (PV) of flow under consideration x 100%

The lower the sensitivity margin, the more sensitive the decision to the particular parameter being considered.

The following tabular approach is the preferred layout for the NPV calculation.

Time Cash flow Discount factor (DF) at x% PV

Question 1

Risk and Uncertainty

Answer 1

Risk - Quantifiable - Possible outcomes have associated probabilities which can be assigned to a range of expected outcomes arising from an investment project.

Uncertainty - Unquantifiable - Outcomes cannot be mathematically modelled.

Question 2

Probability analysis

Answer 2

EV = Sum px

p = the probability of an outcome
x = the value of an outcome

Question 3

Simulation

Answer 3

Sensitivity analysis considers the effect of changing one variable at a time.

Simulation looks at the impact of many variables changing at the same time.