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ACCA AFM · Guided practice (Show me how)

Chapter 10: Risk and Uncertainty

Sensitivity analysis of a project's estimates

Priya has just set up a new company and estimates that its cost of capital is 15%. Her first project involves investing $150,000 in equipment with a life of 15 years and a final scrap value of $15,000. The equipment will produce 15,000 units a year, each generating a contribution of $2.75. Additional fixed costs will be $15,000 a year.

(a) Determine whether the project is worthwhile. (b) Calculate the sensitivity of the NPV to changes in: (i) the initial investment; (ii) the sales volume; (iii) the contribution per unit; (iv) the fixed costs; (v) the scrap value. (c) Comment on the results.

Table factors at 15%: annuity 15 years 5.847, year 15 discount factor 0.123.

  1. (a) Is the project worthwhile?

    Calculate the present value of Priya's contribution and the net present value of the project.

  2. (b) Sensitivity of each estimate

    Calculate the sensitivity of Priya's net present value to investment, volume, unit contribution, fixed costs and scrap value.

  3. (c) What the results say

    Identify the estimates that are most critical to Priya's investment decision and explain the limitations of sensitivity analysis.

Opening this exercise…