Sensitivity Analysis

A sensitivity analysis examines how a result changes when individual assumptions are varied. For example, one changes growth or the interest rate and observes the effect on company value. This shows which assumptions have a particularly strong influence on the result.

It is usually presented as a table with two variables changed at once, such as cost of capital and long-term growth in a discounted cash flow model, or entry and exit multiple in a buyout return calculation. Its usefulness rests on two points. First, the analysis shows which assumptions actually drive value, which focuses discussion on the few relevant questions. It often emerges that a heavily debated detail barely matters while the discount rate dominates the result. Second, it makes clear that a valuation produces a range and not a point value, which matters for communication with boards and in negotiations. A sensitivity analysis should be distinguished from scenario analysis, in which several assumptions are combined into internally consistent states, such as a downturn scenario with simultaneously lower growth, weaker margins and higher working capital needs.

For lenders scenario analysis is decisive, because it shows whether covenants are met even if the plan is missed. This is supplemented by named scenarios, typically a base, downside and upside case, each with an internally consistent set of assumptions rather than an isolated change to individual inputs. It matters that the range of assumptions tested is disclosed, because a narrow range conveys a confidence the calculation does not support.