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What is a discount factor and how is it used? What is an annuity and how does an annuity factor simplify appraisal? How does inflation affect capital budgeting, and how is it handled? How does working capital investment feature in project appraisal? Why is NPV considered superior to payback and ARR? How do NPV and IRR differ when ranking mutually exclusive projects? What is the cost of capital and how is it used as the discount rate? How is risk incorporated into capital budgeting decisions? How do taxes and depreciation (capital allowances) affect project cash flows? How do you appraise projects with unequal lives?
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Budgeting & Forecasting › Capital Budgeting

What is sensitivity analysis in capital budgeting and how is it interpreted?

Intermediate

Answer

Sensitivity analysis flexes one input at a time (sales, price, cost, discount rate, life) to see how much each can change before NPV becomes zero (the breakeven), identifying the variables the decision is most sensitive to. Highly sensitive variables warrant closer estimation and risk management.
NPV falls to zero if sales volume drops 8% -> volume is a key sensitivity.
Real-world example Sensitivity analysis reveals the project's NPV is most vulnerable to the sales-price assumption.

Common follow-ups: What does the breakeven point show? | Why focus on sensitive variables?

Capital Budgeting Rolling Forecasts Capital Budgeting
All 34 Capital Budgeting questions