# Investment Appraisal Under Uncertainty – Sensitivity Analysis (example 1)

1. says

Mr John nice to know you
I greatly need your help on sensitivity analysis

It on the fact that how to calculate sensitivity of selling price

• says

You take exactly the same approach as for the others.

Calculate the present value of the revenue flows (because they are the flows that will change if the selling price changes).

The sensitivity is then the NPV as a percentage of the PV just calculated.

2. Hi John, permit me ask you this question. how do you go about calculating the sensitivity of the price. I mean the percentage of the price change that will lead to the NPV falling to zero
thank you

• says

For this particular example we can not, because we do not know the estimated selling price.
In general terms you would take the same approach as the others i.e. express the NPV as a % of the present value of those cash flows that would change (which in the same of the price would be the sales revenue flows).

• you mean NPV/ present value of sales revenue? this will give me the percentage change in sales revenue. I am preparing for P4 and there is this question Dec 2012 question that asked for this. when i tried going through the solution i didnt understand how it was solved. If use this your approach i will get the percentage change in sales revenue but the question asked for sales price

• says

But surely, if the sales price changes by 10% then the revenue changes by 10% as well!
(I know it could be affected by other things, but with sensitivity we can only consider one item at a time)

One other thing is that if there is tax in the question, then the flows that will change if the selling price changes will be the revenue and the tax on the revenue. So you need the net PV of these two. Then express the NPV of the project as a % of it.

3. says

Thanks John,
an issue here,when we are calculating the sensitivity of change on for example part (iii) which is contribution p.u, why do we put that negative sign yet in our table the final value was a positive??

• says

To show that we are only worried about the contribution falling. (If the contribution increased then there would be no problem at all)

4. says

Now the F9 carries a MCQ do I need to read the text book from cover to cover, or your notes, lectures and the kit will be sufficient to help me pass the exam.

• says

Our notes and lectures (together with lots of practice using a Revision Kit) are enough to be able to pass the exam.

• says

Thank you very much. I understand your lectures more than the text book and and my lecturer. I hope you keep on lecturing we need you.

5. says

Hello Sir,
why lower the sensitivity—> the more worried about item.? how about the higher sensitivity, is the higher sensitivity more optimal? could u plz explain it again. thanks

• says

Its not really a question of calling it the optimum.

The problem is that we are making a decision on forecasts of cash flows, and therefore the actual cash flows may turn out to be different – if they are different then the NPV might turn out to be negative and then we will have made the wrong decision.

The higher the sensitivity the less the chance is of that flow changing enough to affect the decision. However if the sensitivity is low, then it means that even just a small change in the flow will affect the decision. Therefore the lower the sensitivity the more risk we are taking and therefore the more we will try to estimate the flow accurately (or else maybe decide not to take the risk).

• says

great explanation dear sir
thanks alot

6. says

Sir if calculation of tax given then how we calculate present value of relevant cash flow ?

7. says

Sir, will the requirements be given in exam asking us which sensitivity to calculate, the initial investment, sales volume, selling price, etc.?