Question

Discuss about payback period and sensitivity analysis. Please explain when they are used. Write down in your language what you understood. Don’t write the definition directly from the book.

Answer 1

Payback Period is the time it takes to recover the investment cost. Suppose a software is purchased for $ 10000 and due to software savings/profit increase is $ 5000 per year. The payback period is 2 years.

The payback period is one of the techniques in capital budgeting. This assists management in selecting one project over the other. If there are multiple projects from which management wants to decide the one will less payback period is selected.

Sensitivity analysis is an analysis to determine how different values of the independent variables affect a particular dependent variable under a given set of assumptions. Suppose a store owner wants to know during festive season what will be the sale of a particular item in his / her store. The store owner finds out that with a 10% increase in visits in his/her store the sale increases by 2%. Thus by gauging the increase in visitors in his / her store during the festive season the store owner can predict his/her sales.

Sensitivity analysis can be used in business, economics, biology, geography engineering, etc.

Sensitivity analysis is financial analysis, It is used for predicting bond price for various coupon rates and yield to maturity, study company's net working capital on its profit margin, study scenarios of various shocks in global market etc.