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Sensitivity Analysis Handout

Sensitivity Analysis Handout - California Polytechnic State...

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California Polytechnic State University – San Luis Obispo Industrial and Manufacturing Engineering Department IME 314 – Engineering Economic Analysis Sensitivity Analysis Determining Sensitivity to Parameter Variation The term parameter is used to represent any variable or factor for an estimate or stated value is necessary. Example parameters are: first cost, salvage cost, annual operating cost, estimated life, production rates, materials costs, etc. Estimates such as loan interest rates and inflation rates are also parameters of the analysis. Sensitivity analysis uses estimates of a parameter’s future value to assist decision makers. Since these future estimates are always estimates and may be flawed, it is always a good idea to see how each of the important parameters can affect the decision making based on their variation. Or how sensitive is the final decision to the approximate values given to these estimated parameters. Sensitivity analysis determines how a measure of worth – PW, AW, ROR or B/C – and the selected alternative will be altered if a particular parameter varies over a stated range of values. For example, variation in a parameter such as MARR would not alter the decision to select an alternative when all compared alternatives return considerably more than the MARR; thus the decision is relatively insensitive to variations in MARR. However, variation in the n value may indicate that selection from the same alternatives is very sensitive to estimated life. Usually the variations in life, annual costs, and revenues result from variations in selling price, operation at different levels of capacity, inflation, etc. For example, if an operating level of 90% of airline seating capacity for a domestic route is compared with 50% for a proposed international route, the operating cost and revenue per passenger mile will increase, but anticipated aircraft life will probably decrease only slightly. Usually several important parameters are studied to learn how the uncertainty of estimates affects the economic analysis.

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