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Scenario and Sensitivity Analysis

Scenario analysis is a strategic process that analyzes decisions by considering alternative possible outcomes, rather than making predictions. It uses plausible scenarios to help manage uncertainty. The purpose is to approximate potential conditions, not identify exact scenarios. Sensitivity analysis determines how much an output value changes given variations in input factors. It helps find optimal input levels and increase understanding of relationships between inputs and outputs. Both techniques involve defining multiple scenarios or inputs and analyzing how they affect outcomes.

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191 views3 pages

Scenario and Sensitivity Analysis

Scenario analysis is a strategic process that analyzes decisions by considering alternative possible outcomes, rather than making predictions. It uses plausible scenarios to help manage uncertainty. The purpose is to approximate potential conditions, not identify exact scenarios. Sensitivity analysis determines how much an output value changes given variations in input factors. It helps find optimal input levels and increase understanding of relationships between inputs and outputs. Both techniques involve defining multiple scenarios or inputs and analyzing how they affect outcomes.

Uploaded by

hirarafi2002
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Scenario Analysis

Scenario analysis is a strategic process of analyzing decisions by considering


alternative possible outcomes (sometimes called "alternative worlds"). It is
not a predictive mechanism, but rather an analytic tool to manage
uncertainty today. The purpose of scenario analysis is not to identify the
exact conditions of each scenario; it just needs to approximate them to
provide a plausible idea of what might happen

KEY POINTS

Scenario analysis is designed to see the consequences of an action


under different sets of factors. For example, it shows how an
investment's NPV would differ under high and low inflation.
Scenarios should be feasible enough to provide an accurate picture of
the outcomes. A "good" scenario for an investor should not include
winning the lottery because, though good, it is neither probable nor
realistic for analyzing possible results.
Many scenario analyses use 3 scenarios: base case, worst case and
best case. However, the number and conditions of the scenarios in
each analysis can vary.

For example, a bank might attempt to forecast several possible scenarios for
the economy (e.g. rapid vs. moderate vs. slow growth) or it might try to
forecast financial market returns (for bonds, stocks and cash) in each of
those scenarios. Perhaps, it might also consider sub-sets of each of the
possibilities. It might further seek to determine correlations and assign
probabilities to the scenarios (and sub-sets if any). By analyzing these
various scenarios, the bank will be in a better position to consider how best
to allocate its assets.

Sensitivity Analysis
Sensitivity analysis determines how much a change in an input will affect the
output.

KEY POINTS

Since variations from the base assumptions are expected,


businessmen and women want to know how much their output (eg.,
revenue) will be affected by the variations.

Sensitivity analysis helps find the optimal levels for inputs (eg., raw
material prices, number of employees, sales price) .
Sensitivity analysis is a statistical tool based on seeing how inputs and
parameters affect outputs. Generally, each input is changed one at a
time to see how it affects output. However, this does not account for
interconnectedness between inputs; they may not be independent
variables.

Sensitivity analysis is a statistical tool that determines how consequential


deviations from the expected value occur. Sensitivity Analysis deals with
finding out the amount by which we can change the input data for the output
of our linear programming model to remain comparatively unchanged. This
helps us in determining the sensitivity of the data we supply for the problem.
It also helps to determine the optimal levels of each input.
Sensitivity analysis can be useful for a number of reasons, including:

Support decision making or the development of recommendations for


decision makers (e.g., testing the robustness of a result).
Enhance communication from modelers to decision makers (e.g., by
making recommendations more credible, understandable, compelling
or persuasive).
Increase understanding or quantification of the system (e.g.,
understanding relationships between input and output variables).
Model development (e.g., searching for errors in the model).

In order to conduct a sensitivity analysis, all of the inputs and parameters are
connected via an algorithm to produce the output. For example, a model of
the inputs and parameters for a company interest in creating a new product
may include information about expected availability of raw material, inflation
rates, and number of employees working in R&D. The output would be the
profit generated by the new product. The sensitivity analysis entails
changing each variable and seeing how that changes the output . Generally,
only one variable is changed at once, with all of the others fixed at their base
value. This makes it easy to see how much a variable affects the output.
However, not all of the inputs may be independent so changing inputs one at
a time does not account for interaction between the inputs.

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