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Chapter 8: Sensitivity and Breakeven Analysis
Analyzing project risks by making mechanical trial and error changes to forecast values of selected variables.
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Introduction
• Analyzing the risks of investment projects, by changing the values of forecasted variables.
• Finding the values of particular variables which give the project a Breakeven NPV of zero. 2
Process of Analysis
• Identification of those variables which will have significant impacts on the NPV, if their future values vary around the forecast values.
• The variables having significant impacts on the NPV are known as ‘sensitive variables’.
• The variables are ranked in the order of their monetary impact on the NPV.
• The most sensitive variables are further investigated by management. 3
Management Use of Sensitivity and Breakeven Analysis
Using Sensitivity:
Sensitive variables are investigated and managed in two ways:
• (1) Ex ante; in the planning phase; more effort is used to create better forecasts of future values. If management decides the project is too risky, it is abandoned at this stage.
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Management Use of Sensitivity and Breakeven Analysis
Using Sensitivity:
Sensitive variables are investigated and managed in two ways:
•(2) Ex post; in the project execution phase; management monitors the forecasted values. If the project is performing poorly, it is abandoned or sold off prior to its planned termination.
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