What are the different types of sensitivity analysis techniques used in risk assessment for capital budgeting?

There are several types of sensitivity analysis techniques used in risk assessment for capital budgeting. These techniques help assess the impact of changes in key variables on the project's financial outcomes. Some of the commonly used sensitivity analysis techniques include:

1. Scenario analysis: This technique involves analyzing the project's financial performance under different scenarios or assumptions. It helps identify the best and worst-case scenarios and their potential impact on the project's profitability.

2. Sensitivity analysis: Sensitivity analysis involves varying one variable at a time while keeping other variables constant to determine the effect on the project's financial metrics. It helps identify the variables that have the most significant impact on the project's profitability.

3. Break-even analysis: Break-even analysis determines the level of sales or production at which the project's revenues equal its costs, resulting in zero profit or loss. It helps assess the project's risk by identifying the minimum level of sales required to cover costs.

4. Monte Carlo simulation: Monte Carlo simulation involves running multiple iterations of a project's financial model by randomly varying input variables within their specified ranges. It helps generate a probability distribution of possible outcomes, providing a more comprehensive understanding of the project's risk.

5. Sensitivity tornado diagram: A sensitivity tornado diagram visually represents the sensitivity analysis results by ranking the variables based on their impact on the project's financial metrics. It helps identify the most influential variables and their potential impact on the project's profitability.

6. Decision tree analysis: Decision tree analysis involves mapping out different decision paths and their associated probabilities and outcomes. It helps assess the risk and potential profitability of different investment options by considering the uncertainties and potential outcomes at each decision point.

These sensitivity analysis techniques provide valuable insights into the potential risks and uncertainties associated with capital budgeting decisions, allowing decision-makers to make more informed choices.