Sensitivity Analysis
Learn how to test the robustness of your financial models by analyzing how changes in key variables affect outcomes.
What is Sensitivity Analysis?
Sensitivity analysis tests how different values of an independent variable affect a particular dependent variable under a given set of assumptions. It's a way to predict the outcome of a decision given certain variables.
Core Question
What if our assumptions are wrong?
Sensitivity analysis helps you understand which variables have the most impact on your results and how much "room for error" you have.
Investment Decisions
Test how changes in growth rate affect valuation
Project Planning
Analyze cost overrun impacts on ROI
Risk Management
Identify which risks matter most
Why It Matters
Financial models are built on assumptions. Sensitivity analysis reveals which assumptions are critical and how confident you need to be in them.
Identify Key Drivers
Know which variables have the biggest impact on your outcome so you can focus your research and monitoring efforts.
Quantify Risk
Understand the range of possible outcomes and how likely you are to achieve your targets.
Better Decisions
Make more informed choices by understanding the conditions under which your investment succeeds or fails.
Communicate Uncertainty
Present stakeholders with a realistic view of possibilities rather than a single point estimate.
One-Way Sensitivity Analysis
One-way analysis varies a single input while holding all others constant, showing how changes in that one variable affect the output.
Example: NPV Sensitivity to Discount Rate
| Discount Rate | NPV | Change |
|---|---|---|
| 6% | $285,000 | +42% |
| 8% | $240,000 | +20% |
| 10% (Base) | $200,000 | �?/td> |
| 12% | $165,000 | -17% |
| 14% | $135,000 | -32% |
A 2% increase in discount rate reduces NPV by ~17%. This investment is sensitive to cost of capital assumptions.
Two-Way Sensitivity Analysis
Two-way analysis varies two inputs simultaneously, creating a matrix of outcomes that shows how combinations affect results.
NPV: Discount Rate vs. Growth Rate
| Growth Rate �?/th> | |||||
|---|---|---|---|---|---|
| Discount �?/th> | 1% | 2% | 3% | 4% | 5% |
| 8% | $180K | $220K | $265K | $315K | $380K |
| 10% | $120K | $160K | $200K | $245K | $300K |
| 12% | $75K | $115K | $155K | $195K | $240K |
| 14% | $40K | $80K | $120K | $160K | $200K |
Tornado Charts
Tornado diagrams rank variables by their impact on the output, showing which factors create the widest range of outcomes.
Impact on NPV (±20% change in each variable)
Revenue growth has the biggest impact—focus your due diligence here.
Scenario Analysis
Scenario analysis examines complete "what if" situations by changing multiple variables together to represent different possible futures.
Pessimistic
- Growth: 1%
- Costs: +15%
- Discount: 14%
Base Case
- Growth: 3%
- Costs: As planned
- Discount: 10%
Optimistic
- Growth: 6%
- Costs: -10%
- Discount: 8%