Sensitivity Analysis

One measure which expresses risk in more precise terms is sensitivity analysis. It provides information as to how sensitive the estimated project parameters, namely, the expected cash flow, discount rate and the project life are to estimation errors. The analysis on these lines is important as the future is always uncertain and there will always be estimation errors. Sensitivity a takes care of estimation errors by using a number of possible outcomes in evaluating a project. The method adopted under sensitivity analysis is to evaluate a project using a number of estimate cash flows to provide to the decision maker an insight into the variability of the outcomes.

Sensitivity analysis provides different cash flow estimates under three assumptions: (i) the wc (i.e. the most pessimistic), (ii) the expected (i.e. the most likely). and (iii) the best (i.e. the most optimistic) outcomes associated with the project.

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