Aswath Damodaran 254
What does sensitivity analysis tell us?
Assume that the manager at Aracruz who has to decide on whether to take this
plant is very conservative. She looks at the sensitivity analysis and decides
not to take the project because the NPV would turn negative if the price drops
below $ 335 per ton. (Though the expected price per ton is $ 400 , there is a
significant probability of the price dropping below $ 335 .)Is this the right
thing to do?
a) Yes
b) No
Explain.
Sensitivity analysis will reflect the risk aversion of the decision maker. There is a
danger here that we are double counting some risk (by using a higher discount
rate and doing the what-if) and counting in some firm-specific risk (which
should be diversifiable to our investors).
