Sensitivity Analysis (10m)

Question 1

Define NPV

Answer 1

Superior capital budgeting technique. However, it excludes sunk costs

(A positive NPV could still be a money loser)

Question 2

Define Sensitivity Analysis

Answer 2

• Analysis of NPV calculations and how they can change with regards to changes in assumptions

(Also known as “what if” analysis)

Question 3

What is the 3 “BOP” process?

Answer 3

• Best
• Optimistic
• Pessimistic

If 2/3 give positive answer = accept NPV

Looks at one specific variable at a time, so expects all other variable to meet expectations

Question 4

Limitation of Sensitivity Analysis

Answer 4

• Unwillingly increases false sense of security between managers (Pessimistic forecast always 20% less than expected)
• Only treats variables as individual processes, therefore managers are likely to make wrong decisions

Question 5

Scenario Analysis

Answer 5

• Process of analysing future events by considering alternative possible outcomes, therefore does not try to show one exact picture of the future

Question 6

Monte Carlo Simulation

Answer 6

• Technique used to understand the impact of risk and uncertainty
• Helps visualise most or all of potential outcomes to have a better idea regarding risk of a decision

Therefore, providing improved decision making