Sensitivity Analysis

One measure which expresses risk in precise terms is sensitivity analysis. It provides information as to how sensitive the estimated project parameters, such as; the expected cash flow, the discount rate and the project life are to estimation errors.

Sensitivity Analysis takes care of estimation errors by using a number of possible outcomes in evaluating a project. The method adopted under the sensitivity analysis is to evaluate a project using a number of estimated cash flows to provide to the decision maker an insight into the variability of the outcomes. The sensitivity analysis provides different cash flows estimates under three assumptions: the worst (the most pessimistic); the expected (the most likely); and the best (the most optimistic) outcomes associated with the project.