3. Sensitivity and scenario analysis

Different techniques for analyzing project risk require different input variables and assumptions.

The procedure in which one of the elements (or variables) affecting a projects expected value is changed to study its effect on the expected value is called analysis.

Anusha is a risk analyst. She is conducting a sensitivity analysis to evaluate the riskiness of a new project that her company is considering investing in. Her risk analysis report includes the sensitivity curve shown on the graph.

-20-15-10-505101520NPV (Millions of Dollars)CHANGE IN UNITS SOLD (Percent)Base CaseUnits SoldBase CaseNPV

This curve implies that the project is very sensitive to changes in units sold. The projects NPV is likely to become negative if the number of units sold decreases by .

Along with the sensitivity analysis, Anusha is including a scenario analysis for the project in her report, giving the probability of the project generating a negative NPV. Her report includes the following information about the scenario analysis:

Data Collected

Outcome	NPVjNPVj	Probability
		(PjPj)
Pessimistic	$-2.31 million	0.50
Most likely	$4.53 million	0.35
Optimistic	$12.11 million	0.15

Probability Data for z

z	0.03	0.06	0.09
0.4	0.3336	0.3228	0.3121
0.6	0.2643	0.2546	0.2451
0.8	0.2033	0.1949	0.1867
1.0	0.1515	0.1446	0.1379

Complete the missing information in Anushas report:

The expected net present value of the project is .

Standard deviation of the net present value (the NPV of the project is likely to vary by) million. Assuming that probability distribution is normal, the value of z is .

Thus, the project has a chance to generate an NPV of less than $0.