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CS Professional · Strategic Management and Corporate Finance · Project Evaluation

A project's base-case NPV is Rs 6,00,000. The firm finds that NPV falls to zero if sales volume falls 20% from the base estimate, but NPV falls to zero only if the cost of capital rises 60%. What does this indicate about the project's risk?

The project is more sensitive to sales volume, because only a 20% fall in sales brings NPV to zero, whereas the cost of capital must rise 60%. In sensitivity analysis, the variable with the smaller break-even change is the more critical one.

  1. AThe project is more sensitive to sales volume than to cost of capital, so sales volume is the more critical variableCorrect
  2. BThe project is more sensitive to cost of capital than to sales volume
  3. CThe project has no risk because NPV is positive
  4. DBoth variables are equally critical

Explanation

A smaller percentage change in sales (20%) wipes out the NPV than for the cost of capital (60%), so NPV is more sensitive to sales volume. Management should focus on forecasting and controlling sales. Option B reverses this logic.

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