6. Sensitivity and scenario analysis

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

The procedure in which a set of key elements affecting the expected value are changed to study the effect on the expected value is called selector 1sensitivity analysis.

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Explanation:

Zhi 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.

-30-24-18-12-60612182430NPV (Millions of dollars)CHANGES IN SELLING PRICE (Percent)Base Case NPVBase Case Price

This curve implies that the project is very sensitive to changes in the price of the product. The projects NPV is likely to become negative if the price for which the product can be sold decreases by selector 1

8%

12%

.

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Explanation:

Along with the sensitivity analysis, Zhi 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	NPVjNPV	Probability (Pj)
Pessimistic	$3.50 million	0.20
Most likely	$5.62 million	0.45
Optimistic	$11.34 million	0.35

Complete the missing information in Zhis report:

The expected net present value of the project is selector 1

$2.66 million

$1.93 million

$1.03 million

$5.80 million

.

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Standard deviation of the net present value (the NPV of the project is likely to vary by) selector 1

$7.13

$5.30

$6.16

$6.56

million.

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