Question

Decision Theory: Discuss how sensitivity analysis can be utilized in cost control using examples when preventative or detective objective measure values are not available.  

Answer 1

Sensitivity analysis is a way of analysing change in the project’s NPV or IRR for a givenchange in one of the variables under a given set of hypothesis. It indicates how sensitive a project’s NPV or IRR is tochanges in particular variables. The more sensitive the NPV, the more critical is the variable. One of the forecast variables while carrying out such analysis cost done through budgeting.

Every project involves risk and uncertainty during implementation. That being said, the plan for project implementation and the expected result of the project could vary from the actual results realized.

In absence of preventive and detective measures, sensitivity analysis can be used to control cost by showing how marginal a project is. For instance, if a slight change in prices of inputs or outputs changes the NPV from positive to negative, then the project is said to be marginal. In this case, project sensitivity analysis demands that proper cost control be eshtablished to control the marginality of a project. Cost control may include proper management of the distribution cost, which may affect prices of a product or offering.