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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

A project's NPV at the company's cost of capital is $2.4m. Management wants to know by what percentage the sales volume could fall before the NPV becomes zero, in order to identify which assumptions the project outcome is most exposed to. Which technique is being used, and what does a small percentage indicate?

This is sensitivity analysis, where one variable is flexed until NPV becomes zero. A small permitted fall in sales volume shows the project's value is highly sensitive to that assumption, so management should monitor it closely and consider ways to reduce the exposure.

  1. ASensitivity analysis; a small percentage means the NPV is highly sensitive to that variable, so it needs close monitoringCorrect
  2. BScenario analysis; a small percentage means the variable has low risk because it can be controlled
  3. CSimulation; a small percentage means the NPV distribution is narrow
  4. DDecision tree analysis; a small percentage means the probability of failure is low

Explanation

Calculating how far one variable can change before NPV reaches zero is sensitivity analysis (a break-even margin of safety for the variable). A small margin means a small adverse change would eliminate the project's value, so the variable is critical. It does not combine several variables, assign probabilities or model distributions.

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