3. Sensitivity and scenario analysis Different techniques for analyzing project risk require different input variables and assumptions. in the Suppose you are using the scenario analysis technique to evaluate project risk. You would change model to evaluate the effect of the input factors on the expected value. one input variable at a time Paloma is a risk analyst. She is conducting a sensitivity analysis to evaluate the riskiness of a new several input variables together Jering investing in. Her risk analysis report includes the sensitivity curve shown on the graph. Paloma is a risk analyst. She is conducting a sensitivity analysis to evaluate the riskiness of a new project that her company is considering investing in. Her risk analysis report includes the sensitivity curve shown on the graph. ? NPV (Millions of Dollars) Base Case NPV Best Case Cost of Capital 0 3 6 9 12 15 COST OF CAPITAL (Percent) if the cost of This curve implies that the project is not very sensitive to changes in cost of capital. The project's NPV is likely to capital increases to 15%. become negative stay positive foject generating Along with the sensitivity analysis, Paloma is including a scenario analysis for the project in her report, giving the a negative NPV. Her report includes the following information about the scenario analysis: Along with the sensitivity analysis, Paloma is including a scenario analysis for the project in her report, giving the probability of the project generating a negative NPV. Her report includes the following information about the scenario analysis: Data Collected Outcome Probability (P;) 0.20 NPV; $-3.50 million $5.62 million Pessimistic Most likely 0.45 Optimistic $11.34 million 0.35 Probability Data for z 0.03 0.06 0.09 0.4 0.3336 0.3228 0.3121 0.6 0.2643 0.2546 0.2451 0.8 0.2033 0.1949 0.1867 $2.66 million 1.0 0.1515 0.1446 0.1379 $1.03 million $5.80 million Complete the missing information in Paloma's re $1.93 million The expected net present value of the project is Complete the missing information in Paloma's report: The expected net present value of the project is million. Assuming that probability distribution is normal, Standard deviation of the net present value (the NPV of the project is likely to vary by) the value of z is Thus, the project has a chance to generate an NPV of less than $0