Sensitivity Analyses Concept

Sensitivity Analyses Concept

Sensitivity analyses is very important concept in investment appraisal and gives you a basic understand that how the different variable can change the cash inflows and outflows. Sensitivity analyses are performed with the help of sensitivity margin.

Formula of Sensitivity Margin

Sensitivity Margin =           Net present Value­­­­­­­ of the Project under consideration

                                           Present value of under consideration Cash flows 

Sensitive analyses for cost is performed in term of how much cost can rise to bring the NPV to a zero level and for revenues it is analyzed that how much a revenue can fall to bring the NPV value to Zero.      

Example of Sensitivity Margin

 Initial investment is $ 70,000 and expected cash flow for year is $ 30,000 for four years. Calculate the sensitivity Margin for the investment.  Cost of Capital is 12%.

1.       Calculate present value of cash inflows

$ 30,000 x 3.037 (annuity Factor)

$ 91,110

2.       Calculate NPV

NPV = Present value inflow – Present value of out flows

= $ 91,110- $ 70,000

= $ 21,110

3.       Calculate Safety Margin

= NPV/Present value of Cash flow (under consideration)

= $ 21,110/70,000

=30.15%

Because investment is expense therefore investment may further rise to 30.15% before the NPV becomes zero.