Sensitivity Analysis

CA Sangeeta Pandit
HOD Finance
SIMSREE
 Risk Analysis
Risk and Business Decisions
Capital Budgeting Decisions
Expository convenience risk of
existing & new investments-same-
average cost of capital
Risks differ-R & D, expansion,
replacement
 Evaluation of Investments
Financial Analysts evaluate projects
in 2 phases
1. Calculate NPV, IRR..
2. Risk Analysis
Risk Analysis techniques are very
precise but they rely on information
that is subjective
 Techniques of Risk Analysis
Two Categories
(1) Stand-Alone Risk
(2) Risk in context of Firm or Market
 Different Techniques
Technique
s
Scenario Analysis

Stand Contextu
-Alone al

Sensitivity Scenario
Analysis Analysis
Corp.Ris Market
k Risk
Break-even Hillier Model Analysis Analysi
Analysis
s
Simulation Decision Tree
Analysis Analysis
 Sensitivity Analysis: How sensitive is your
finding of NPV, IRR .. to a change in one
of the variables, like sales, expenditure..
Scenario Analysis: How sensitive is your
finding of NPV, IRR .. to a change in
more variables, typically-the 3 scenarios
are considered-exp.opt.pessim
Break-Even-Financial Break even
Hilliers Model: Mathematical model
 Simulation : Computer aided-
softwares-exogenous variables,
stochastic in nature)
Decision tree: start from the left &
starts branching off
 Sources of Risk
Project Risk
Competitive
Industry-specific
Market risk
International Risk
 Measures of Risk
Range
Standard Deviation
Coefficient of variation
Semi-variance
 Example
NPV Probability
200 .3
600 .5
900 .2
 Calculation of
(Probability Weighted NPV) Expected Value
.3*200+.5*600+.2*900=540
1.Range is 900-200=700
2.Standard deviation ( sigma)
= square root of: .3*(200-540)2+.5(600-540)2 +.2(900-540)2 =
62400 sq.root=249.8
3. Variance= ()= 62400
4. Co-efficient of variation=CV= /Expected Value
=249.8/540=.46
Semi-Variance (only negative outcomes considered)
= .3(200-540)2 = 34680
Semi-standard deviation=sq. root of variance=186.2
Sensitivity Analysis is What
if ?
Tries to understand what will happen
to the viabilty of a project if some
variable like sales/raw material
cost/etc. deviates from its expected
value
 Example
A firm is contemplating investment of
Rs.20000 in a project of 10 yrs. It is
estimated that annual: Sales-Rs.18,000.
Variable exp-Rs.12000(66.67%), Fixed
Costs-Rs.1000, Depreciation would be 10%
(SLM), Tax @ 33.33% & cost of capital is
12%. (PV factor-5.650)
NPV=-20,000+4000*5.650=2600
2nd stage to analyse risk by sensitivity
analysis
Sensitivity to NPV due to change in
variable
Fig are in 000
 Exercise
A project of 2 yrs costing Rs.7000
has cash outflows of Rs.2000 &
Rs.2500 in year 1 & year 2 resp. It
will result in savings of Rs.6000 &
Rs.7000 in year 1 & 2 resp. If cost of
capital is 8% measure the sensitivity
of the three variables to NPV
becoming zero