Discuss the following statement: “A project may not be very risky in spite of its high sensitivity to certain variables.”

Explanation

In sensitivity analysis, the risk of a project is measured by changing the one input variable to see its impact on the net present value (NPV). However, there can be certain scenarios where even if the input variable might result in a greater change in the NPV, but the NPV does not change to a large extent. This happens because the NPV might be too sensitive to that input variable but the change in that variable is not very likely; thereby, the NPV does not change to a greater extent.

Verified Answer

There are some input variables whose change can affect the net present value of a project to a large extent. However, the likelihood of changes in that input variable is very low. Thus, even if other input variables change and the input variable whose impact on NPV is very high does not change, the NPV will not deviate from its expected value.