Question

Enlighten on how can one conduct sensitivity analysis by using CVP analysis, what is the relevance in managerial decision making?

Answer 1

Sensitivity analysis is an analysis which helps in analyzing the investment at various levels of activities. It helps in understanding how various alternatives are performing at different levels of activity so that best alternative can be selected. CVP analysis if one of the tools used to do sensitivity analysis

Since CVP analysis divides cost structure into variable cost and fixed cost various alternatives can be evaluated with different cost structure. Variable cost per unit remains same per unit and fixed cost remains same at overall level. Different level of sales can be projected with different levels of cost and profitability.

Relevance of Sensitivity analysis by using CVP analysis in managerial decision making

• It helps in various decision making like pricing, make vs buy, product profitability, shut down vs continue, launch of new product, division profitability, etc
• It is a risk management tool. It helps in selecting the best alternative after doing the risk study with sensitivity analysis.              
• Decision made with sensitivity analysis are reliable and sound as it gives significant management insights