Differentiate between sensitivity analysis and scenario analysis. What advantage does scenario analysis have over sensitivity analysis?
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Differentiate between sensitivity analysis and scenario analysis. What advantage does scenario analysis have over sensitivity analysis? |
Explanation
The difference between the sensitivity analysis and scenario analysis are as follows:
Number of inputs: In case of sensitivity analysis, the number of input variables to be changed are only one, whereas in case of scenario analysis, all the variables are changed to estimate the net present value (NPV) in different scenarios.
Usage of probability: While computing the NPV using the sensitivity analysis, there is no probability assigned to the input variable. However, probabilities are assigned to all the scenarios in case of scenario analysis to determine the expected NPV.
The scenario analysis is better than the sensitivity analysis because it takes into consideration the impact of different input variables on the NPV of a project. It provides a more realistic approach to the expected NPV because the likelihood of changes only in the single input variable is very low.
Verified Answer
The sensitivity analysis and scenario analysis differentiate on the basis of the number of inputs to be changed during the projection of the net present value (NPV). In sensitivity analysis, only one input variable is changed; however, in case of scenario analysis, more than one input variable is changed to determine the expected NPV.
The scenario analysis is better than the sensitivity analysis because it provides a more realistic approach to the expected NPV of a project by taking into consideration different scenarios wherein the inputs variables can change. Sensitivity analysis does not look at the bigger picture.
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