Question

Sensitivity analysis is a technique that...

A. shows how results differ when underlying assumptions change

B. analyzes the effect of an investment on workers morale

C. evaluates the different available investment options

D. sets the budgets of alternative investment opportunities

Answer 1

Sensitivity analysis is a technique that shows how results differ when underlying assumptions change.

Explanation -

Sensitivity analysis is also known as WHAT-IF Analysis. It determines how independent variables of a business have effect on dependent variables.

Example -

Sales = $10000

- Cost of goods sold = $4000

= Profit = $6000

Profit = Sales - Cost of goods sold

In this example, sales and cost of goods sold are independent variables and profit is dependent variable. If underlying assumptions are changed such as 10% change in sales, then profit would be,

Present sales = $10000

If sales increase by 10% = $10000 × 110%

= $11000

Profit would be =

= $11000 - $4000

= $7000

Change in profit if there is change in sales by 10%

= $7000 - $6000/$6000 × 100

= 16.66%

Or we can say, profit is 16.66% sensitive to 10% increase in sales.

In this way, if underlying assumptions changes, results differ. This is known as sensitivity analysis.

Therefore, the correct answer is option (A).