Varying r (discount rate) or cash flow reveals sensitivity of NPV to assumptions.
Understanding the Inputs
Initial Investment
The upfront cost of the project that will be recovered through future cash flows. This is the amount invested at time zero.
Annual Cash Flow
The net cash received each year from the project. This is typically the revenue minus operating expenses.
Project Life
The total duration of the project in years. This determines how many years of cash flows will be discounted.
Variable to Test
The input variable you want to vary to see how it impacts NPV. You can test either the discount rate or the annual cash flow while keeping other variables constant.
Start Value, End Value, and Step
These define the range and granularity of the sensitivity analysis. Start and end values set the testing range, while step determines the increment between each test value.
Related Calculators
Explore other financial analysis and modeling calculators
Sensitivity Analysis is a risk assessment technique that systematically measures how changes in an individual input variable affect a key output metric (e.g., Net Present Value, profit margin, or required sales volume) in a financial model.
The 'What-If' Principle
The analysis operates on the **'What-If'** principle: holding all other variables constant, what happens if the sales price drops by 5%? Or, what happens if the cost of capital increases by 100 basis points? By isolating one variable at a time, the model identifies the **key drivers**—the variables that exert the greatest influence on the final result.
Risk Tolerance Metric
The output of sensitivity analysis quantifies the model's susceptibility to changes in assumptions. A model that shows a large change in the output metric resulting from a small change in an input variable is considered **highly sensitive** and, therefore, riskier.
Modeling Mechanics: Isolating a Single Variable
Performing sensitivity analysis involves running the model multiple times while systematically varying one input variable across a defined range (e.g., $\pm 10\%$).
Defining the Range
The input range must be plausible. For variables with high uncertainty (e.g., market share, commodity prices), a wider range (e.g., $\pm 20\%$) is often appropriate. For variables with low uncertainty (e.g., cost of debt, equipment lifespan), a narrow range (e.g., $\pm 5\%$) is used. This process generates a spectrum of possible outcomes.
The Tornado Diagram
The results of sensitivity analysis are often summarized visually in a **Tornado Diagram**. This chart lists the input variables in descending order of their impact on the output metric. The variable at the top of the "tornado" is the most critical driver of the project's success or failure, allowing management to focus risk mitigation efforts there.
Key Output Metrics: Break-Even Point Calculation
One of the most valuable outputs of sensitivity analysis is the **Break-Even Point (BEP)**—the threshold at which the project generates neither profit nor loss (NPV equals zero).
Calculation for Capital Budgeting
For investment analysis (like Net Present Value - NPV), the break-even point is the value of an input variable that causes the NPV to drop from positive to zero. For example, if the initial NPV is $1$ million dollars, the analyst can determine the required decrease in the sales price that would make the NPV zero.
Break-Even Point = Input Value that sets NPV = 0
Interpretation as Margin of Safety
The difference between the expected value of an input variable and its break-even value is the **Margin of Safety**. A large margin of safety indicates that the project can absorb significant adverse changes in that variable and remain viable, signaling lower risk.
Sensitivity vs. Scenario Analysis (Risk Spectrum)
Sensitivity analysis and Scenario Analysis are both tools for risk modeling but address different parts of the risk spectrum.
Sensitivity Analysis (Local View)
Sensitivity analysis provides a **local view** of risk. It tests one variable's elasticity at a time, providing mathematical precision. It is excellent for answering focused questions like, "How much does the required rate of return have to change before the project becomes unprofitable?"
Scenario Analysis (Global View)
Scenario analysis provides a **global view** of risk. It changes multiple, correlated variables simultaneously to simulate a plausible future state (e.g., a recession, a trade war). It is better suited for holistic risk assessment, showing the total impact of systemic risk.
Ideally, firms use sensitivity analysis first to identify the three to five most critical variables, and then use scenario analysis to model the impact of those variables moving together.
Applications in Capital Budgeting and Valuation
Sensitivity analysis is indispensable across all areas of finance where future uncertainty exists.
Capital Budgeting Decisions
When evaluating large capital expenditure (CapEx) projects, sensitivity analysis helps firms decide which projects to fund. If two projects have similar expected NPVs, the firm will choose the one with the lowest sensitivity to key variables like sales volume or input cost, as this represents lower financial risk.
Valuation and Due Diligence
In mergers, acquisitions, and equity valuation (using Discounted Cash Flow - DCF), sensitivity analysis is performed on the discount rate (WACC) and the Terminal Value growth rate. This reveals the range of fair value for the target company based on minor adjustments to the most uncertain and high-impact modeling assumptions.
Conclusion
Sensitivity analysis is the foundational risk tool in financial modeling, isolating the impact of changes in a single input variable on a key output metric. Its value lies in identifying the **key drivers** of a model through the use of the **Tornado Diagram**.
By determining the **Break-Even Point** and the resulting **Margin of Safety**, decision-makers can quantify the risk tolerance of an investment, ensuring that high-value projects are selected based not only on potential returns but also on their inherent stability under varying economic assumptions.
Frequently Asked Questions
Common questions about sensitivity analysis and what-if scenarios
What is sensitivity analysis and why is it important?
Sensitivity analysis tests how changes in one key variable affect a financial model's output. It helps identify which variables have the most impact on project viability and where decision-makers should focus attention.
How is sensitivity analysis different from scenario analysis?
Sensitivity analysis varies one variable at a time while keeping others constant. Scenario analysis changes multiple variables simultaneously to represent different plausible outcomes (best case, base case, worst case).
What variables should I test in sensitivity analysis?
Focus on variables that are uncertain or have significant impact: discount rates, revenue projections, costs, project timing, and key assumptions. These are typically the inputs management has least control over.
How do I interpret sensitivity analysis results?
Look for the break-even point where NPV becomes zero, the range of NPV variation, and how steep the curve is. Steeper curves indicate higher sensitivity to that variable.
What is a tornado diagram in sensitivity analysis?
A tornado diagram is a graphical representation that shows which variables have the greatest impact on the output, ranked by sensitivity. Variables are displayed horizontally with the most sensitive at the top.
Should I test all variables simultaneously or one at a time?
Start with one-at-a-time sensitivity analysis to identify key drivers. Then use scenario analysis to test combinations of variables changing together, which reflects real-world correlations.
How do I determine realistic ranges for variables to test?
Base ranges on historical data, industry benchmarks, expert opinions, and statistical confidence intervals. Consider both historical variation and future uncertainties.
What does a positive NPV in all scenarios mean?
A positive NPV across all tested scenarios indicates a robust project that remains profitable even under adverse conditions. This provides confidence in the investment decision.
How do I present sensitivity analysis results to stakeholders?
Use charts, tables, and summary statistics. Highlight the most sensitive variables, break-even points, and the range of possible outcomes. Emphasize what drives project risk.
Can sensitivity analysis help with risk management?
Yes. By identifying key risk drivers, sensitivity analysis helps focus risk mitigation efforts on the variables that most affect project outcomes. This enables proactive risk management strategies.
Summary
Sensitivity analysis tests how changes in one variable affect financial outcomes.
Identifies the most critical assumptions and their break-even thresholds.
Best used alongside scenario analysis to capture correlations between variables.
Embed This Calculator
Add this calculator to your website or blog using the embed code below:
<div style="max-width: 600px; margin: 0 auto;">
<iframe
src="https://mycalculating.com/category/finance/sensitivity-analysis-what-if-calculator?embed=true"
width="100%"
height="600"
style="border:1px solid #ccc; border-radius:8px;"
loading="lazy"
title="Sensitivity Analysis What If Calculator Calculator by MyCalculating.com"
></iframe>
<p style="text-align:center; font-size:12px; margin-top:4px;">
<a href="https://mycalculating.com/category/finance/sensitivity-analysis-what-if-calculator" target="_blank" rel="noopener">
Use full version on <strong>MyCalculating.com</strong>
</a>
</p>
</div>
Analyze how changing one variable impacts a financial model\'s outcome.
How to use Sensitivity Analysis / "What-If" Calculator
Step-by-step guide to using the Sensitivity Analysis / "What-If" Calculator:
Enter your values. Input the required values in the calculator form
Calculate. The calculator will automatically compute and display your results
Review results. Review the calculated results and any additional information provided
Frequently asked questions
How do I use the Sensitivity Analysis / "What-If" Calculator?
Simply enter your values in the input fields and the calculator will automatically compute the results. The Sensitivity Analysis / "What-If" Calculator is designed to be user-friendly and provide instant calculations.
Is the Sensitivity Analysis / "What-If" Calculator free to use?
Yes, the Sensitivity Analysis / "What-If" Calculator is completely free to use. No registration or payment is required.
Can I use this calculator on mobile devices?
Yes, the Sensitivity Analysis / "What-If" Calculator is fully responsive and works perfectly on mobile phones, tablets, and desktop computers.
Are the results from Sensitivity Analysis / "What-If" Calculator accurate?
Yes, our calculators use standard formulas and are regularly tested for accuracy. However, results should be used for informational purposes and not as a substitute for professional advice.