Sensitivityand Breakeven Analysis 285
From the discussionand the examples,we see thatpaybackperiod can be helpful in providing
a measure of the speed of the return of the investment. This might be quite important,
for example, for a company that is short of working capital or for a firm in an industry
experiencing rapid changes in technology.Calculation of payback period alone, however,
must not be confused with a careful economic analysis. Wehave shown that a short payback
period does not always mean that the associated investment is desirable. Thus, payback
period should not be considered a suitable replacement for accurate economic analysis
calculations.
Graphing with Spreadsheets for Sensitivity and Breakeven Analysis
Since many data gathere~in solvinga problemrepresentprojectionsof future consequences;
there may be considerableuncertaintyregarding the data's accuracy.Since the desiredresult
of the analysis is decision making, an appropriate question is, To what extent do variations
in the data affect my decision? When small variations in a particular estimate would change
selection of the alternative, the decision is said to be sensitive to the estimate. To better
evaluate the impact of any particular estimate, we compute "the variation to a particular.
estimate that would be necessary to change a particular decision."This is called sensitivity
analysis.
An analysis of the sensitivityof a problem's decisionto its variousparameters highlights
the important and significant aspects of that problem. For example, one might be concerned
that the estimates for annual maintenance and future salvage value in a particular problem
may vary substantially. Sensitivity analysis might indicate that the decision is insensitive
to the salvage-value estimate over the full range of possible values. But, at the same time,
we might find that the decision is sensitive to changes in the annual maintenance estimate.
Under these circumstances, one should place greater emphasis on improving the annual
maintenance estimate and less on the salvage-valueestimate.
As indicated at the beginning of this chapter, breakeven analysis is a form of sensi-
tivity analysis. To illustrate the sensitivity of a decision between alternatives to particular
estimates, breakeven analysis is often presented as a breakeven chart..
Sensitivity and breakeven analysisfrequently are useful in engineering problems called
stage construction. .Should a facility be constructed now to meet its future full-scale
requirement, Or should it be constructed in stages as the need for the increased capac-
ity arises? Three examples of this situation are:
·Should we install a cable with 400 circuits now or a 200-circuit cable now and another
200-circuit cable later?
·A 10 cm water main is needed to serve a new area of homes. Should it be installed
now, or should a 15 cm main be installed to ensure an adequate water supply to
adjoining areas later, when other homes have been built?
·An industrial firm needs a new warehouse now and estimates that it will need to
double its size in 4 years. The firm could have a warehouse built now and later
enlarged, or have the warehouse with capacity for expanded operations built right
away.
Examples 9-9 and 9-10 illustrate sensitivity and breakeven analysis.
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