Project Risk Analysis: Techniques for Measuring Stand-Alone Risk 315
We see, then, that we need to extend sensitivity analysis to deal with the probability
distributionsof the inputs. In addition, it would be useful to vary more than one vari-
able at a time so we could see the combined effects of changes in the variables. Sce-
nario analysisprovides these extensions—it brings in the probabilities of changes in
the key variables, and it allows us to change more than one variable at a time. In a sce-
nario analysis, the financial analyst begins with the base case,or most likely set of val-
ues for the input variables. Then, he or she asks marketing, engineering, and other op-
erating managers to specify a worst-case scenario(low unit sales, low sales price,
high variable costs, and so on) and a best-case scenario.Often, the best case and
worst case are set so as to have a 25 percent probability of conditions being that good
or bad, and a 50 percent probability is assigned to the base-case conditions. Obviously,
conditions could actually take on other values, but parameters such as these are useful
to get people focused on the central issues in risk analysis.
The best-case, base-case, and worst-case values for RIC’s computer project are
shown in Table 8-4, along with a plot of the data. If the product is highly successful, then
FIGURE 8-1 Evaluating Risk: Sensitivity Analysis (Dollars in Thousands)
NPV at Different Deviations from Base
Deviation from Year 1
Base Case Sales Price Variable Cost/Unit Growth Rate Units Sold Fixed Cost WACC
30% ($27,223) $29,404 ($ 4,923) ($ 3,628) $10,243 $9,030
15 (10,707) 17,607 (115) 1,091 8,026 7,362
0 5,809 5,809 5,809 5,809 5,809 5,809
15 22,326 (5,988) 12,987 10,528 3,593 4,363
30 38,842 (17,785) 21,556 15,247 1,376 3,014
Range $66,064 $47,189 $26,479 $18,875 $8,867 $6,016
NPV
($)
40,000
30,000
20,000
10,000
0
–10,000
–20,000
–30,000
–30 –15 01530
Deviation from Base-Case Value (%)
Sales price
Growth rate
Units sold
WACC
Fixed cost
Variable cost
314 Cash Flow Estimation and Risk Analysis
