Identication and Appraisal Analysis 2022
Added on 2022-06-01
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Sensitivity Analysis De ned
Procedures in Sensitivity Analysis
Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Sensitivity Analysis
Break-even Analysis
Sensitivity Analysis Defined
chala Project Identi cation....
The f i nancial and socio-economic analysis of investment
projects discussed in chapter 2 is based on forecast of
quantifiable variables.
The values of these variables are
Estimated based on the most probable forecasts.
Influenced by a great number of factors and the actual
valuesmay differ considerably from the forecasted values.
It is therefore useful to consider the effects of likely changes
inthe key variables on the viability of the project.
We can do this performing sensitivity analysis.
The viability of projects is evaluated based on a comparison of
its NPV (the project is said to be viable if the is NPV
positive).
Procedures in Sensitivity Analysis
Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Sensitivity Analysis
Break-even Analysis
Sensitivity Analysis Defined
chala Project Identi cation....
The f i nancial and socio-economic analysis of investment
projects discussed in chapter 2 is based on forecast of
quantifiable variables.
The values of these variables are
Estimated based on the most probable forecasts.
Influenced by a great number of factors and the actual
valuesmay differ considerably from the forecasted values.
It is therefore useful to consider the effects of likely changes
inthe key variables on the viability of the project.
We can do this performing sensitivity analysis.
The viability of projects is evaluated based on a comparison of
its NPV (the project is said to be viable if the is NPV
positive).
Sensitivity Analysis De ned
Procedures in Sensitivity Analysis
Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Sensitivity Analysis
Break-even Analysis
Sensitivity Analysis Defined
chala Project Identi cation....
Sensitivity analysis focuses analyzing the effects of changes
in key variables on the project's IRR or NPV, the two most
widely used measures of project worth. of use, flexibility and
low cost.
Sensitivity analysis typically involves posing what if?
Questions.
For example, what if demand fell by 10% compared to our
original forecasts? Would the project still be viable?
In project appraisal, sensitivity analysis assesses how responsive the
project's NPV is to changes in the variables used to calculate that
NPV.
The NPV could depend on a number of uncertain independent
variables: (a) Selling price, (b) Sales volume, (c) Cost of
capital, (d) Initial cost, (e) Operating costs, (f) Benefits, etc.
Sensitivity analysis therefore provides an indication of why a
project might fail.
Procedures in Sensitivity Analysis
Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Sensitivity Analysis
Break-even Analysis
Sensitivity Analysis Defined
chala Project Identi cation....
Sensitivity analysis focuses analyzing the effects of changes
in key variables on the project's IRR or NPV, the two most
widely used measures of project worth. of use, flexibility and
low cost.
Sensitivity analysis typically involves posing what if?
Questions.
For example, what if demand fell by 10% compared to our
original forecasts? Would the project still be viable?
In project appraisal, sensitivity analysis assesses how responsive the
project's NPV is to changes in the variables used to calculate that
NPV.
The NPV could depend on a number of uncertain independent
variables: (a) Selling price, (b) Sales volume, (c) Cost of
capital, (d) Initial cost, (e) Operating costs, (f) Benefits, etc.
Sensitivity analysis therefore provides an indication of why a
project might fail.
chala Project Identi cation....
Sensitivity Analysis
Break-even Analysis
Sensitivity Analysis
Sensitivity Analysis De ned
Procedures in Sensitivity Analysis
Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Management should
Review critical variables to assess whether or not there is a
strong possibility of events occurring which will lead to a
negative NPV.
Pay particular attention to controlling those variables to
Which the NPV is particularly sensitive, once the decision
hasbeen taken to accept the investment.
A simple approach to deciding for which variables the NPV
is sensitive to is to calculate the sensitivity of each variable:
Sensitivity = NPV
PV of project variable x 100% (1)
The lower the percentage, the more sensitive is NPV to
that project variable as the variable would need to change by a
smaller amount to make the project non-viable.
Sensitivity Analysis
Break-even Analysis
Sensitivity Analysis
Sensitivity Analysis De ned
Procedures in Sensitivity Analysis
Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Management should
Review critical variables to assess whether or not there is a
strong possibility of events occurring which will lead to a
negative NPV.
Pay particular attention to controlling those variables to
Which the NPV is particularly sensitive, once the decision
hasbeen taken to accept the investment.
A simple approach to deciding for which variables the NPV
is sensitive to is to calculate the sensitivity of each variable:
Sensitivity = NPV
PV of project variable x 100% (1)
The lower the percentage, the more sensitive is NPV to
that project variable as the variable would need to change by a
smaller amount to make the project non-viable.
Alemu L. Project Identi cation....
Sensitivity analysis is a technique for investigating the impact
of changes in project variables on the base-case (most
probableoutcome scenario).
Typically, only adverse changes are considered in sensitivity
analysis.
The purpose of sensitivity analysis is:
To help identify the key variables which influence the
projectcost and benefit streams
To investigate the consequences of likely adverse changes in
these key variables
To assess whether project decisions are likely to be affected
bysuch changes
To identify actions that could mitigate possible adverse
effectson the project.
Sensitivity Analysis De ned
Sensitivity Analysis Procedures in Sensitivity Analysis
Break-even Analysis Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
The Purpose of Sensitivity Analysis
1
2
3
4
Sensitivity analysis is a technique for investigating the impact
of changes in project variables on the base-case (most
probableoutcome scenario).
Typically, only adverse changes are considered in sensitivity
analysis.
The purpose of sensitivity analysis is:
To help identify the key variables which influence the
projectcost and benefit streams
To investigate the consequences of likely adverse changes in
these key variables
To assess whether project decisions are likely to be affected
bysuch changes
To identify actions that could mitigate possible adverse
effectson the project.
Sensitivity Analysis De ned
Sensitivity Analysis Procedures in Sensitivity Analysis
Break-even Analysis Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
The Purpose of Sensitivity Analysis
1
2
3
4
Alemu L. Project Identi cation....
To meet the above purposes, the following steps are
recommended to be followed:
Identify key variables to which the project decision may be
sensitive.
Calculate the effect of likely changes in these variables on
thebase-case NPV, and calculate a sensitivity indicator
and/or switching value.
Consider possible combinations of variables that may change
simultaneously in an adverse direction.
Analyze the direction and scale of likely changes for the key
variables identified, involving identification of the sources of
change.
Sensitivity Analysis De ned
Sensitivity Analysis Procedures in Sensitivity Analysis
Break-even Analysis Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Procedures in Sensitivity Analysis
1
2
3
4
To meet the above purposes, the following steps are
recommended to be followed:
Identify key variables to which the project decision may be
sensitive.
Calculate the effect of likely changes in these variables on
thebase-case NPV, and calculate a sensitivity indicator
and/or switching value.
Consider possible combinations of variables that may change
simultaneously in an adverse direction.
Analyze the direction and scale of likely changes for the key
variables identified, involving identification of the sources of
change.
Sensitivity Analysis De ned
Sensitivity Analysis Procedures in Sensitivity Analysis
Break-even Analysis Applying the Sensitivity Tests
Developing Pessimistic and Optimistic Forecasts
Procedures in Sensitivity Analysis
1
2
3
4
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