ACCA FM Syllabus D. Investment Appraisal - Sensitivity Analysis - Notes 2 / 5
How sensitive is the project to ONE particular variable
It basically shows as a % how much ONE variable has to change before the NPV becomes zero
The smaller the % change needed the more focus managers should give the item generally
The Calculation
The smaller the percentage, the more sensitive the decision is to a change in the variable
Illustration
ACCA colleges are considering a project which will cost them an initial 10,000
The cashflows expected for the 2 year duration are 10,000pa.
The variable costs are 1,000pa
Cost of capital 10%
Calculate the sensitivity analysis of all variables
Solution
PV of project as a whole:
| Year | 0 | 1 | 2 |
| Investment | (10,000) | ||
| Costs | (1,000) | (1,000) | |
| Sales | 10,000 | 10,000 | |
| Discount Factor | 1 | 0.909 | 0.826 |
| Discounted Cashflows | (10,000) | 8,181 | 7,434 |
So the NPV as a whole is 5,615
Sensitivity of Initial Investment
5,615 / 10,000 = 56%
Sensitivity of Costs
5,615 / (909 + 826) = 323%
Sensitivity of Sales
5,615 / (9,090 + 8,260) = 32%
Advantages of Sensitivity Analysis
It identifies all the critical factors, which can be focused on by managers.
It gives managers information for decision making.
It is easy to calculate and explain to managers from accountant perspective.
Weakness of Sensitivity Analysis
Each variable must change in isolation
Yet they are often interdependent upon each other
It does not take into account probabilities of change occurring
Some factors management may not control