Question 7.S-TQ5: Discuss how sensitivity analysis can help managers to assess...

Sensitivity analysis examines how responsive the project’s NPV is to changes in the variables from which it has been calculated. There are two methods: in the first, variables are changed by a set amount and the NPV is recalculated; in the second, the amounts by which individual variables would have to change to make the project’s NPV become zero are determined. In both methods, only one variable is changed at a time.

Both methods give an indication of the key variables within the project. These variables may merit further investigation and indicate where management should focus attention in order to ensure the success of the project. However, sensitivity analysis gives no indication of whether changes in key variables are likely to occur, or are even possible.