Capital Budgeting Techniques: Sensitivity, Scenario, Break-even and Simulation Analysis

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Corporate financial management

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Introduction
In the business, there are various decisions which are made and for that it is required that
available tools shall be used. By this the effective decision making will be made possible and
improvement in the business operations will be attained. There are many techniques which are
available for the capital budgeting decisions and they include sensitivity analysis, scenario
analysis, breakeven analysis and simulation. All of them have certain aspects which help the
business to grow and they shall be understood in appropriate manner. The details in this respect
will be provided below.
a. Sensitivity analysis
In the business, there are various investments which are made and for that there is the use of
various techniques which are identified to be the capital budgeting tools. There will be
involvement of various aspects which needs to be considered such as the risk involved together
with the uncertainty (Baños-Caballero, García-Teruel and Martínez-Solano, 2014). The results
which will be obtained by the investment will be different from the expected ones and this will
be considered to be the variance. If there will be high deviation then the risk will be increased.
This will be analyzed with the help of sensitivity analysis in which the changes in the variables
will be considered together with their impact on the final results of NPV and other calculations.
There will be determination of the rate at which the change in the IRR and NPV will be made
with the deviation in the variable factors.
This will help to evaluate the project in which investment is being considered and this will be
performed in advance. There will be an identification of the risk and all other aspects and with
the help of their best decision will be made possible (Baio and Dawid, 2015). This will be done
in such manner that the investment which is being made will be provided with the best results
and increase the return which is the main motive behind capital budgeting.
In this process, there are various steps which need to be performed and by that the effective
results will be obtained. There will be various estimates which will be made in relation to the
variables by which all the decisions will be made (Rodríguez et al., 2013). There will be proper
analyzation which will be made of all the variables in which the fluctuations which will be taking

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place will be identified. There will be determination of the changes and then the percentage form
of the same will be calculated.
The process which is provided will be taken into consideration and by that the company will be
able to avoid the losses which the world have otherwise faced due to the risk and uncertainty.
There will be various benefits which will be attained and identification of all the assumptions
which are made will be possible. There will be appropriate forecasting which will be made
possible by the use of the results that are obtained (Sarrazin, Pianosi and Wagener, 2016). The
risk which is involved will be determined and then the steps in that respect will be taken to
overcome them. There are certain man aspects which need to be given importance such as the
required data will have to be collected properly. The process is little complex and so it becomes
difficult for the manager to understand it and this is a demerit of the process. By taking all of
these in consideration there will be best decisions which will be made.
b. Scenario analysis.
The company will be involving carrying out of various operations and for that, there will be
various investments which will be required to be made and it is needed that they all shall be
identified in effective manner. The probability of the various conditions which are involved will
be taken so that proper evaluation of them can be made (Victor, 2012). The value will be
determined with the help of this and there will be identification of the occurrence probability.
By the help of this, all the risks which are involved in the business will be identified which are
present in relation to the investments which are considered by the organization. In the process of
decision making the risk involved will be compared with the return which will be available by
the project. For all the investors there is the tolerance level up to which they are ready to take the
risk and the same will be identified in advance (Zhang et al., 2012). All of the situations will be
compared and the one which will be provided with the best results will be identified.
There are several issues which are faced in this process and they will be identified so that the
steps to overcome them can be planned beforehand by which the adverse impacts will be
avoided. This technique involves various benefits and demerits and they need to be identified
before undertaking the process. The outcome which will be received will be used for various