What is Scenario Analysis? How it is different from Sensitivity Analysis?

Scenario analysis: It is also known as “what if” analysis. It helps to take decision of uncertain future. It is complex then sensitivity analysis. It shows that how NPV varies if more than one variable are changed simultaneously.

Example: A company manufactures a product C whose sales price is Rs.70 per unit and the cost of production is Rs.5, 50,000.It is estimated that the price of product will be decreases by Rs.5 or may be increases by Rs.10.Find out the NPV with scenario analysis. Other information is as follows:

Product C (unit)	8000	10000	6000
Cost of goods sold	30000	20000	25000
Selling and distribution expenses	10000	8000	14500
Sales Price	75	70	85

Solution:

Particulars	Base Price	Price decreases	Price increases
Sales	6,00,000	7,00,000	5,10,000
Cost of goods sold	(30,000)	(20,000)	(25000)
Gross Profit	5,70,000	6,80,000	4,85,000
Selling and distribution expenses	(10,000)	(8000)	(14500)
Net Profit	5,60,000	6,72,000	4,70,500

NPV of base price =Rs. (5, 60,000-5, 50,000)

=Rs.10, 000

NPV of price decreases=Rs. (6, 72, 000-5, 50, 000)

=Rs.1,22, 000

NPV (price increases) = Rs. (4, 70,500-5, 50,000)

=- 79,500

So, if the price of product decreases, NPV and production volume both will be increases but if increases, NPV and production both will be decreases.

Let’s try to solve another example which helps to understand difference between scenario analysis and sensitivity analysis.

Sensitivity Analysis:

Example: Company X purchase loss incurring company Z in Rs.72, 00,000 and after that Company Z product Y demand increase in the market due the goodwill of company X, so the cost of marketing of product reduces by 10%.Find out the NPV.

Particulars	Company Z
Sales	90,00,000
Cost of goods sold	20,00,000
Marketing expenses	15,00,000
Other income	20,00,000

Solution:

Particulars	Company Z (before sold to X)	Company Z (after purchase by X)
Sales	90,00,000	90,00,000
Cost of goods sold	(20,00,000)	(20,00,000)
Gross Profit	70,00,000	70,00,000
Marketing expenses	(15,00,000)	(13,50,000)
Operating income	55,00,000	56,50,000
Other income	20,00,000	20,00,000
Net Profit	70,00,000	76,50,000

NPV (Company Z (before sold to X)) = Rs. (70, 00,000-72, 00,000)

= -Rs.2, 00,000

NPV (Company Z (after purchase by X)) =Rs. (76, 50,000-72, 00,000)

= Rs. 4, 50,000

By reducing 10% of marketing cost NPV turns positive. It shows that other things remain same, only a change in one variable vary NPV.

Scenario Analysis

Example: Find out the NPV for next 3 years if it is forecasted that product price will decreases in future .Other information are as follows:

Particulars	Current year	1st year
Sales per unit	90	80
Cost of goods sold	3000	-
Unit	250	300

*Company invests Rs.15, 000 to launch a product.

* Production also increases every 50 unit

*5% price decreases every year.

*Other expenses decreases 3%

Cost of goods sold is Rs.4000, Rs.3500 and Rs.2200 respectively for 3 years.

Solution:

Particulars	Current Price @Rs.90	1st Year @Rs.85	2nd Year @ Rs.80	3rd Year @ Rs.75
Sales	22500	25500	28000	30000
Cost of goods sold	(6000)	(4000)	(3500)	(3000)
Gross profit	16500	21500	24500	27000
Other expenses	(3000)	(2910)	(2822)	(2737)
Net Profit	13500	18590	21678	24263

NPV (current Price) = Rs. (13500-15000)

= -Rs.1500

NPV (1^st year) = Rs. (18590-15000)

= Rs. 8590

NPV (2^nd year) = Rs. (21678-15000)

=Rs.6678

NPV (3^rd year) = Rs. (24263-15000)

= Rs.9263

 By decreasing price of a product the demand of a product increases are decrease and the NPV shows positive results. So, decrease in price of a product in future will be good for the company.