Sensitivity Analysis and Scenario Analysis
How can the firm get the net present value technique to live up to its potential? One approach is sensitivity analysis, which examines how sensitive a particular NPV calculation is to changes in underlying assumptions. Sensitivity analysis is also known as what-if analysis and bop (best, optimistic, and pessimistic) analysis.
Consider the following example. Solar Electronics Corporation (SEC) has recently developed a solar- powered jet engine and wants to go ahead with full-scale production. The initial (year 1)1 investment is
$1,500 million, followed by production and sales over the next five years. The preliminary cash flow
projection appears in Table 7.1. Should SEC go ahead with investment in and production of the jet engine, the NPV at a discount rate of 15 percent is (in millions):