Investment Appraisal Under Uncertainty – Sensitivity Analysis (example 1)

ACCA F9 lectures ACCA F9 notes


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    • Profile photo of John Moffat 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.

    • Profile photo of John Moffat 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).

      • Profile photo of questforknowledge says

        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

      • Profile photo of John Moffat 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.

  1. avatar 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??

    • Profile photo of John Moffat 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).

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