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ACCA Strategic Professional · Strategic Business Leader · Identification, assessment and measurement of risk

Davenport Retail's finance team recalculates a new store project's NPV by changing the sales volume assumption by 10% while holding all other assumptions constant, and notes the NPV falls by $120,000. Which statement about this technique is correct?

This is sensitivity analysis. It changes one variable, sales volume, while holding others constant to show how much NPV responds. Its limitation is that it does not indicate how likely the change is and ignores interactions between variables.

  1. AIt is sensitivity analysis, and it shows how responsive NPV is to one variable but not the likelihood of that changeCorrect
  2. BIt is Monte Carlo simulation, and it gives a probability distribution of NPV
  3. CIt is value at risk, and it states the loss at a confidence level
  4. DIt is scenario analysis, and it changes several variables together in a coherent storyline

Explanation

Changing one input while holding others constant is sensitivity analysis. It identifies critical variables but gives no probability of the change occurring and ignores interaction between variables. Monte Carlo varies many inputs using distributions, and scenario analysis changes several variables together.

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