fm12 2 - e. Sensitivity analysis indicates exactly how much...

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Answers and Solutions: 12 - 2 e. Sensitivity analysis indicates exactly how much NPV or other output variables such as IRR or MIRR will change in response to a given change in an input variable, other things held constant. Sensitivity analysis is sometimes called “what if” analysis because it answers this type of question. Scenario analysis is a shorter version of simulation analysis that uses only a few outcomes. Often the outcomes considered are optimistic, pessimistic and most likely. Monte Carlo simulation analysis is a risk analysis technique in which a computer is used to simulate probable future events and thus to estimate the profitability and risk of a project. f. A risk-adjusted discount rate incorporates the risk of the project’s cash flows. The cost of capital to the firm reflects the average risk of the firm’s existing projects. Thus, new projects that are riskier than existing projects should have a higher risk- adjusted discount rate. Conversely, projects with less risk should have a lower risk-
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