The arguments about foreign project valuation

Essay by phkawuahUniversity, Master'sB, February 2003

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Sensitivity analysis is the process of varying the assumptions underlying a decision to determine the decision's sensitivity to those assumptions. It enables managers to assess how responsive NPV is to changes in key variables that are used to calculate it (Drury 1996). Some of the factors that influence the NPV of multinationals are taxes, exchange rates, estimating the terminal value of a project using different methodologies, political risk and the real operating options (Buckley 2000). NPV is calculated using the estimated value of sales, unit to be sold and growth rates. Taking each variable one at a time, the NPV can be computed separately to know what the NPV will be if that variable changes. In order to perform a sensitivity analysis, the firm will need to first pick a base case situation as benchmark for comparison. After picking the base situation, the firm will start changing one of its key variables and determine its impact on the project's NPV.


·Sensitivity analysis gives some idea of stand-alone risk as variables are analysed on their own. Stand-alone risk is the risk the project has by being considered as a separate project. Since a project by a multinational has 'knock on' effects on other projects in the group, there is the need to analyse the NPV of the project without taking the effects on other subsidiaries. The Chilean or Indian project has to be evaluated as a stand-alone project to determine its real NPV.

·It also identifies dangerous variables that will impact negatively on the business. This gives managers immediate answers about possible future events and their influences on NPV. By doing sensitivity analysis, variables that seen as dangerous are identified and managed so as to reduce its impact on the business (Horngren et al 2002)

·Sensitivity analysis gives...