Corporate Finance

Risk Analysis in Capital Investments 
 213

Similarly, the sensitivity of NPV and IRR to changes in other variables like sales growth rate, market

growth could be ascertained individually and in combination. For instance, we can find the sensitivity of

NPV to a combination of:

Project life = 8 years

Price = Rs 475 and Rs 300 respectively

No. of units sold = 10 percent less than the base case

Exhibit 11.1 shows the sensitivity of NPV for changes in operating profit margin and sales growth rate for

a hypothetical project.

Exhibit 11.1 Sensitivity of NPV
Base Case
↓
Sales growth rate NPV (Rs in million)
–1 percent 0 +1 percent
+1 percent 9.50 17.5 25.5
Operating profit 0 2.6 10.6 18.6 ← Base case
margin (percent)
–1 percent (4.3) 3.7 11.7

It is useful to show the results of sensitivity analysis in a graph. The graph can have the profitability

criterion (say NPV) on the Y-axis and the variable (expressed as a percentage of the base case) on the X-axis.

The sensitivity of NPV to the changes in selling price for a hypothetical project is shown in Exhibit 11.2.

Note that when the level of activity (No. of units produced) comes down, other related inputs like working

capital, variable material costs, etc. have to be changed before estimating cash flows. A greater slope indicates

higher sensitivity.

Exhibit 11.2 Sensitivity of NPV to the changes in selling price

300,000

NPV

200,000

100,000

0

–100,000

Percentage of base case

80 90 100 110 120

We assumed a project life of 10 years for the BEL picture tube project. If the life shrinks to 8 years, cash

flows and NPV would be:

(Rs lac)

Year Cash flow

1 –1,410

Table contd.