Explanation

Scenario analysis is a measure of stand-alone risk of a project wherein all the input variables are changed to determine the net present value (NPV) in different scenarios. Generally, the worst-case, most likely and the best-case scenarios are taken to estimate the NPV in these scenarios. Unlike sensitivity analysis, scenario analysis takes into consideration the impact of more than one input variable. It also helps in determining the overall expected NPV of a project by assigning probabilities to the NPVs in each of the scenarios. Moreover, scenario analysis also helps in determining standard deviation and eventually the coefficient of variance to analyze the amount of risk taken to earn one dollar of NPV.

Verified Answer

When more than one input variables are changed by creating different scenarios to estimate the net present value of a project, then such a risk assessment technique is known as the scenario analysis.