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Explain sensitivity and scenario analysis for capital budgeting. How are these types of analysis performed? How...

Explain sensitivity and scenario analysis for capital budgeting. How are these types of analysis performed? How are they alike, how are they different? Why are they necessary?

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Answer #1

Scenario analysis refers to valuation of investment under different scenarios. It reflects how the change of value in investment occurs due to adverse or favourable scenarios.

Sensitivity analysis is used to measure the effect of change of one set of variable onto another set of variable like, a certain percentage of change in risk would lead to a certain percentage of change in reward and volatility.

Difference between the two is that sensitivity analysis is used to to identify the the change in the behaviour of dependent variable by change in the value of independent variable. While scenario analysis is completely independent and it is always calculated in the independent specific scenarios.

Both analysis are similar in the way that they both are used to predict the future of the investment in relation to a specific events and they both are the indicators of risk analysis.

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