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ACCA Applied Skills · Financial Management · Adjusting for risk and uncertainty in investment appraisal

Which of the following techniques is normally used to deal with uncertainty, rather than risk, in investment appraisal, because it does not require probabilities to be assigned to outcomes?

Sensitivity analysis is the technique that deals with uncertainty without needing probabilities. It tests how much a single variable can change before the project NPV falls to zero. Expected NPV, standard deviation and probability distributions all require probabilities, so they are used where risk can be quantified.

  1. AExpected net present value
  2. BStandard deviation of NPV
  3. CSensitivity analysisCorrect
  4. DProbability distribution of NPV

Explanation

Sensitivity analysis examines how far a single variable can change before the NPV becomes zero, without needing probabilities. Expected NPV, standard deviation of NPV and probability distributions all depend on assigned probabilities, so they deal with risk.

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