Sensitivity analysis is one method of analysing the uncertainty surrounding a capital expenditure project and assessment of how responsive the project's NPV is to changes in the variables used to calculate that NPV.
>>The maximum possible change is often expressed as a percentage.

A simple approach to deciding which variables the NPV is particularly sensitive to is to calculate the sensitivity of each variable:

Sensitivity = NPV/PV of cash flow under consideration*100%

The lower the percentage, the more sensitive the NPV is to that variable.
For example:
-If initial investment increases by 1%, the project NPV will be zero.
-If price falls by more than 2%, the project will make a loss.

 

Some key sensitivity ratio:
1. Sensitivity of cost of capital （discount rate）: IRR
2. Sensitivity of sale volume:
3. of contribution （sales revenue-variable costs）
4. Sensitivity of selling price: PV of revenue

The usefulness
·Sensitivity analysis can be used to find the key variable that the least change results in negative NPV.
·Management should assess the possibility of changes of key variable which will lead to a negative NPV.
·Management should also pay particular attention to controlling those most sensitive variables.
·It provides management with more information than a single point


Limitation
·Interaction of factors is not considered as each factor is changed in isolation.
·Sensitivity analysis is analysis when there is uncertainty. It does not examine the probability that any particular variation in costs or revenues might occur.
·Managers may not have any control over those factors identified as being critical to project viability.
·It does not provide decision rules. i.e. it does not provide an indicator of the maximum acceptable level of sensitivity.