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Sensitivity Analysis

Sensitivity analysis is used to analyze how changes in variables impact a project's net present value (NPV) or internal rate of return (IRR). It identifies critical variables, analyzes the mathematical relationships between variables and the NPV, and determines how changes to each variable affect the NPV. Sensitivity analysis can show which variables have the highest sensitivity and the likelihood that adverse changes could alter the feasibility of a project. For example, increasing costs by 10% and decreasing prices by 10% for an oil palm cultivation project reduced the benefit-cost ratio from 1.49 to 1.22 and the IRR from 25% to 20%, making the project less profitable but still feasible.

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509 views

Sensitivity Analysis

Sensitivity analysis is used to analyze how changes in variables impact a project's net present value (NPV) or internal rate of return (IRR). It identifies critical variables, analyzes the mathematical relationships between variables and the NPV, and determines how changes to each variable affect the NPV. Sensitivity analysis can show which variables have the highest sensitivity and the likelihood that adverse changes could alter the feasibility of a project. For example, increasing costs by 10% and decreasing prices by 10% for an oil palm cultivation project reduced the benefit-cost ratio from 1.49 to 1.22 and the IRR from 25% to 20%, making the project less profitable but still feasible.

Uploaded by

rastogi parag
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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SENSITIVITY ANALYSIS

Aliya Zubair
Ankan Langthasa
Avinash D.
Gurashish Singh
M. Venugopal Reddy
Parag Rastogi
Introduction
Sensitivity analysis is a way of analysing
change in the project’s NPV (or IRR) for a
given change in one of the variables
The more sensitive the NPV, the more
critical is the variable
Steps in Sensitivity Analysis
Identification of all those variables, which
have an influence on the project’s NPV
Definition of the underlying (mathematical)
relationship between the variables
Analysis of the impact of the change in
each of the variables on the project’s NPV
Risk and Uncertainty
Risk is referred to a situation where the
probability distribution of the cash flows of
an investment proposal is known.
Uncertainty is different from risk in sense
because here no information is available to
formulate a probability distribution of the
cash flows.
NPV
Total present value of a time series of cash
flows
An indicator of how much value an
investment or project adds to the value of
the firm
NPV= PVB - PVC
IRR
Annualized effective compounded return
rate which can be earned on the invested
capital
A project is a good investment proposition
if its IRR is greater than the rate of return
that could be earned by alternate
investments
In the context of savings and loans the IRR
is also called effective interest rate
Cost-benefit analysis
Weighing the total expected costs against
the total expected benefits
Used to assess the value for money of very
large private and public sector projects
The Benefit-Cost Ratio is given by the
formula:
BCR = Present Worth of Benefits
Present Worth of Costs
Sensitivity Analysis of a Model
Project On Cultivation Of Oil
Palm
Before Sensitivity Analysis
Financial indicators
Discount factor 15%
NPV of costs 97,947

NPV of benefits 146,051

NPV of net benefits 48,104


BCR 1.49
IRR 25%
After Sensitivity Analysis
Financial indicators
Assumptions:
Discount factor 15%
Costs increased by
NPV of costs 107,7
10%
42
Market Prices
NPV of benefits 131,4
decreased by 10%
46
NPV of net 23,70
benefits 4
BCR 1.22
IRR 20%
Conclusion
The BC Ratio has reduced to 1.22.
This means that for one rupee spent, the
returns reduced to Rs. 1.22., which is lower
than the earlier value of Rs. 1.49.
IRR has also reduced from 25% to 20%.
The project is feasible but there is a
reduction in returns after changes.
Sensitivity Analysis can
answer…
Which are the variables with high
sensitivity indicators?
How likely are the (adverse) changes in the
values of the variables that would alter the
project decision?
Thank You

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