What
is Sensitivity
Analysis?
Financial risk modeling takes sensitivity
analysis to the next level and helps in assessing the probability and potential
impact of unfavorable outcomes. Based on the assessments, various decisions
with respect to managing, hedging or transferring risks are taken.
Sensitivity analysis is one of the tools
that help decision makers with more than a solution to a problem. It provides
an appropriate insight into the problems associated with the model under
reference. Finally, the decision maker gets a decent idea about how sensitive the
optimum solution is chosen by him to any changes in the input values of one or
more parameters.
Have you ever been caught in a situation
regarding data sensitivity analysis in Financial Modeling? If you have faced a
problem before, find your answer right here!
Measurement
of sensitivity analysis
Below are mentioned the steps used to
conduct sensitivity analysis:
·
Firstly, the base case output
is defined; say the NPV at a base case input value (V1) for which the
sensitivity is to be measured. All the other inputs of the model are kept
constant.
·
Then the value of the output at
a new value of the input (V2) while keeping other inputs constant is
calculated.
·
Find the percentage change in
the output and the percentage change in the input.
·
The sensitivity is calculated
by dividing the percentage change in output by the percentage change in input.
This process of testing sensitivity for
another input (say cash flows growth rate) while keeping the rest of inputs
constant is repeated till the sensitivity figure for each of the inputs is
obtained. The conclusion would be that the higher the sensitivity figure, the
more sensitive the output is to any change in that input and vice versa.
For
Sensitivity Analysis follow the following steps
First LINK the output you want to check
sensitivity of? (IN FMCG case link the share Price or EV)
Next decide the variable you want to check
the sensitivity of (e.g. WACC; Terminal Growth rate; tax rate etc.)
Let’s say we selected WACC and Terminal
Growth which originally n the model is 10.7% and 5%. Now take the range for two
variable which will be 8.7; 9.7; 10.7;11.7 and 12.7% for WACC and let’s say 3;
4; 5; 6; 7% for T. Growth. Place these numbers on the cell next to your linked
cell in step one above. So, if you have linked EV in the cell G30 Wick will
come in the cell from H30 - L30 and T Growth will come in cell G31 to G35
Now select the cell from G30 to L35 and go
to data tab - "What if Analysis" - "Data table"
Now in the window which pops up in the
"row input" select the cell where you have originally calculated your
WACC and in Column select cell where you have originally calculated T Growth
Rate and press enter
Uses
of Sensitivity Analysis
·
The key application of
sensitivity analysis is to indicate the sensitivity of simulation to
uncertainties in the input values of the model.
·
They help in decision making
·
Sensitivity analysis is a
method for predicting the outcome of a decision if a situation turns out to be
different compared to the key predictions.
·
It helps in assessing the
riskiness of a strategy.
·
Helps in identifying how
dependent the output is on a input value. Analyses if the dependency in turn
helps in assessing the risk associated.
·
Helps in taking informed and
appropriate decisions
·
Aids searching for errors in
the model
Conclusion
Sensitivity analysis is one of the tools that
help decision makers with more than a solution to a problem. It provides an
appropriate insight into the problems associated with the model under
reference. Finally, the decision maker gets a decent idea about how sensitive the
optimum solution is chosen by him to any changes in the input values of one or
more parameters.
To know in-depth about Sensitivity
analysis, read here: https://www.edupristine.com/blog/all-about-sensitivity-analysis
