Question

what are the drawbacks of sensitivity analysis, scenario analysis and break-even analysis?

are they reliable in open market conditons?

Answer 1

Sensitivity analysis is an analysis of the effects of changes in variables like sales, costs etc. on a project. The primary drawback of sensitivity analysis is that the underlying variables are assumed to be independent. This, however, is not so the case in the real world and so the changes of the underlying variable can be initiated only up to a certain extent and not beyond that. Secondly sensitivity analysis may, in some cases, give ambiguous results as it is not always possible to properly define optimistic and pessimistic scenarios.

Scenario analysis is a project analysis under a particular combination of assumptions. Various possible outcomes are speculated in scenario analysis. The primary drawback of scenario analysis is that user bias can be created due to incorrect assumptions. This can lead to incorrect sensitivity to the factors at play.

Break-even analysis involves an analysis of the level of sales at which the company breaks even. The primary drawback of break-even analysis is that its assumption that production and sales are the same at all the time is a faulty assumption. Secondly it applies only to a single product or a single mix of products.

Sensitivity analysis, scenario analysis and break-even analysis are not always reliable in open market conditions because in open market conditions many of the assumptions on which the analysis is based do not hold. Moreover in open market conditions several underlying variables no longer remain independent, rather they become dependent and this limits the use of sensitivity analysis, scenario analysis and break-even analysis.