Teaching guide: sensitivity analysis (for last exams in 2024)

Use this teaching guide in the classroom to engage your students, contextualise the model/theory in real-world business and prepare them for the exam.

Section 3.7.8 Analysing the external environment to assess opportunities and threats.

Overview

When making a decision, managers are unlikely to make only one set of calculations given that all the numbers are based on forecasts. Managers will recognise that there is a range of possible values for revenues and costs. They are likely therefore to undertake sensitivity analysis. This takes an investment forecast and adjusts it for different scenarios. For example, what happens if costs were 5% higher? What if revenues were 2% lower? By calculating a number of different scenarios, managers can see how sensitive the payback, ARR and NPV for a decision is to different situations.

When you can use this

• Many of the decisions managers take will involve investment: investment in marketing, in training, in technology etc. The concepts of payback, ARR and NPV are therefore very useful and can be used to analyse these decisions.
• Sensitivity analysis is a good way of highlighting risk. When large sums of money are involved, risk will be considered. Students can think about risk when any decision is made.