When projects involve certain, or constant, cash flows, the capital budgeting analysis that can be conducted is very simple and straightforward. Unfortunately, this type of project rarely exists.

When a projects cash flows, or the conditions that affect their magnitude or timing, vary from their expected values, then the analysis becomes more complicated. Projects that have the potential to exhibit greater or lesser levels of risk than the firms average, or normal, level means that adjustments should be made to the capital budgeting analysis process.

Several techniques are used to assess the stand-alone risk, which reflects the uncertainty about the projects cash flows. Some of these techniques are (1) sensitivity analysis, (2) scenario analysis, and (3) Monte Carlo simulation.

1. Scenario Analysis or Sensitivity Analysis measures the percentage change in the net present value (NPV) that results from a given percentage change in one of the input variables while all other variables are held constant at their expected values.

2. When performing scenario analysis, the expected net present value (NPV) Will Always Be Equal To or Will Rarely Be Equal To the base-case NPV.