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Sensitivity Analysis

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SuFi Anwar
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19 views7 pages

Sensitivity Analysis

Uploaded by

SuFi Anwar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Sensitivity Analysis

What is Sensitivity Analysis?

 A sensitivity analysis, also referred to as a what-if analysis , is a


mathematical tool used in scientific and financial modeling to study how
uncertainties in a model affect that model's overall uncertainty. It's a way to
determine what different values for an independent variable can do to affect a
specific dependent variable, given a particular set of assumptions. You may use
sensitivity analysis when there are boundaries dependent on input variables and
when you want to answer questions such as:
 Will the study's results change if we use other assumptions?
 How sure are we of these assumptions?
How does sensitivity analysis work?

 You can use sensitivity analysis to study how a specific change may
affect you. For example, if you want to know if a change in interest
rates would affect bond prices if the interest rate increased by 2%.
You can turn this into a "what if" statement, such as the following:
 "What happens to the cost of a bond if the interest rate goes up by
2%?"
Methods for applying sensitivity analysis

 Direct method
In the direct method, you would substitute different numbers into an
assumption in a model. Using the direct method, we substitute different
numbers to replace the growth rate to see the resulting revenue
amounts. For example, if your revenue growth assumption is 20% year
over year, the revenue formula is:
(Last year's revenue) x (1 + 20%)
 Indirect method
In the indirect method, you insert a percent change into formulas
instead of directly changing the value of an assumption. For example,
if your revenue growth assumption is 20% year over year and we know
that the revenue formula is:
(Last year's revenue) x (1 + 20%)
Instead of changing 20% to another number, we change the formula to:
(Last year's revenue) x (1 + (20% + X)), where X is a value in the
sensitivity analysis area of the model.
Benefits of sensitivity analysis
The benefits of using sensitivity analysis are:
 Better decision-making: Sensitivity analysis presents decision-
makers with various outcomes to help them make better business
decisions.
 More reliable predictions: It provides an in-depth study of
variables, making predictions and models more reliable.
 Highlights areas for improvement: Sensitivity analysis helps
decision-makers identify where to make future improvements.
 Provides a higher level of credibility: Sensitivity analysis adds
credibility to financial models by testing them across a broad set of
possibilities.
Examples of sensitivity analysis

 Jane is a sales manager and wants to better understand how the


increase in holiday shoppers affects the total sales for her
department. Using the data from last year's holiday sales, Jane learns
that total holiday sales are a function of transaction volume and
price. She determines that when holiday shoppers increase by 10%,
sales increase by 5%. Jane can build a financial model and use
"what if" statements of sensitivity analysis using this information.
Based on this, Jane now understands that if the increase in holiday
shoppers is 50%, total sales should increase by 25%.

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