Sensitivity Analysis

Time Value of
Capital and Money
Evaluating
Production +
Projects
Cost Depreciation
& Income Tax

Review
 Plant Design

Economic Analysis
based on the estimates that can be
made of the investment required and
the cash flows

What about the actual cash flows ??

IS IT THE SAME ?? OR NOT WHY ??

Sensitivity Analysis

To explore what
Degree of risk involved
happens to a project’s A way of examining the
in making judgments on
profitability when the effects of uncertainties
the forecast
estimated value of in the forecasts on the
performance of the
study factors are viability of a project
project
changed
How To ....

Adjust the
Determine the
parameters, assuming
Parameter (use the Evaluate the Project
a range of error for
most probable values)
each factor in turn
Example

Consider a proposal to enhance the vision system used by a postal

service to sort mail. The new system is estimated to cost $1.1
million and will incur an additional $200,000 per year in
maintenance costs. The system will produce annual savings of
$500,000 each year (primarily by decreasing the percentage of
misdirected mail and reducing the amount of mail that must be
sorted manually). The MARR is 10% per year, and the study period is
five years at which time the system will be technologically obsolete
(worthless).
Determine how sensitive the decision to invest in the system is to
the estimates of investment cost and annual savings.
Example

• An industrial machine costing $14,000 will produce net cash

savings of $5,000 per year. The machine has a five-year useful life
but must be returned to the factory for major repairs after three
years of operation. These repairs cost $5,000. The company’s
MARR is 10% per year. What IRR will be earned on the purchase of
this machine? Analyze the sensitivity of IRR to ± $2,000 changes in
the repair cost.
THANK YOU