The question asked for a critical discussion of sensitivity analysis and probability analysis as ways of including risk in the investment appraisal process, commenting also on the relative effectiveness of each method. Many answers were either not very critical or showed a lack of understanding of this part of the syllabus.

Although the topic of risk and investment appraisal has been examined before, many answers were not of a good standard. A good point from which to start an answer would be explaining the difference between risk and uncertainty. Risk can be quantified (using probabilities) while uncertainty cannot. Sensitivity analysis does not consider risk, since it does not consider probabilities, and is therefore a less effective way of including risk in the investment appraisal process than probability analysis, which seeks to assign probabilities to project variable values or to future investment outcomes. Some answers claimed incorrectly that probability analysis employed the profitability index. Please see the suggested answer for a discussion of sensitivity analysis and profitability analysis.