Sensitivity
Analyses for Cost Example
In sensitivity analyses
for cost, we see sensitivity (reaction) of NPV to cost. We calculate a margin
of safety for cost. There are three steps for these analyses. In first place we
calculate NPV, then we calculated Present value of cost and in last we
calculate margin of safety for cost. (How much cost can be increase to get zero
NPV?
Example of Sensitivity & Variable
|
Initial
Investment
|
200,000
|
|
Volume
of Sales
|
20,000
Units
|
|
Selling
Price
|
12
|
|
Variable
Price
|
8
|
|
Project
term 4 years
|
4
years
|
Cost of Capital is 10%
Solution
1. Calculate NPV
|
Cash
outflow
|
$ 200,000
|
|
Cash
inflow ( $ 20,000 x 4 x 3.170)
|
$ 253,600
|
|
NPV
(253,600-200,000)
|
$ 53,600
|
2. Calculate present Value of Variable Cost
|
Variable Cost ( 20,000 @ 8 )
|
160,000
|
|
Annuity Factor 4 years
|
3.170
|
|
Present Value of Variable Cost
|
$ 507,200
|
|
|
|
|
|
|
3. Margin of safety for contribution
=
$ 53,600/$ 507,200 x 100
=10.56%
Cost
is to be raised by 10.56% to bring the NPV to the level of Zero. Therefore
variable cost is more sensitive to the NPV.
