Sensitivity analysis (or ‘what-if’ analysis) is specifically designed to show how changes in one individual variable (like raw material cost) impact the outcome (e.g., NPV). It directly answers the finance director’s question about the project’s vulnerability to that specific factor, unlike scenario analysis (which changes multiple variables together) or Monte Carlo (which models many variables probabilistically).

This is a classic cost indifference point (or break-even) analysis. By plotting total cost (Fixed Cost + (Variable Cost per Unit * Quantity)) for both the ‘make’ and ‘buy’ options, the intersection of the two lines graphically shows the volume where total costs are equal. This provides a clear decision rule: below this volume, buying is cheaper; above it, making is cheaper.

For mutually exclusive projects, the NPV rule is superior. NPV gives the absolute value added in monetary terms, aligning with the goal of shareholder wealth maximization. The conflict arises because IRR can be misleading with projects of different scales or timings of cash flows. A smaller project can have a high IRR but add less total value than a larger project with a lower IRR but higher NPV.

The initial net investment is the cost of the new asset minus the immediate cash inflow from disposing of the old asset. The relevant figure is the current market value ($25,000), not the accounting book value. Therefore, the net cash outflow at time zero is $150,000 – $25,000 = $125,000. The book value affects the accounting gain/loss on sale for tax, but the cash flow is the sale proceeds.

The primary purpose of a Post-Completion Audit is organizational learning. It compares actual results with the original forecasts and assumptions, identifying why variances occurred. This feedback loop helps improve the accuracy of future forecasts, the realism of assumptions, and the overall capital investment process. It is a forward-looking control tool, not a backward-looking blame exercise.

While the cost of capital reflects the systematic risk of the company, specific, non-diversifiable stand-alone risk of a project can be accounted for by adjusting the discount rate via a risk premium. This is a common practical approach (risk-adjusted discount rate). Alternatively, certainty equivalents could adjust cash flows, but adjusting the rate is more frequently used in practice for dealing with project-specific risk.

WACC should include the cost of all long-term sources of finance (typically debt and equity). The weights should be based on market values, not book values, to reflect the current cost of raising capital. The costs used should be the current marginal costs (e.g., yield to maturity on debt, required return on equity). Short-term finance is usually excluded as it is not part of the permanent capital structure.

The payback period has two major flaws as an investment criterion: 1) It ignores cash flows after the payback point (a project with a 3.5-year payback but no further cash flows is ranked the same as one with high cash flows in years 4-10). 2) It does not discount cash flows, treating a dollar in year 3 the same as a dollar in year 1. Therefore, it should only be used as a supplementary liquidity risk measure, not a primary decision tool.

For a mature company in a stable industry with consistent profits, a market-based approach like the P/E ratio model is often very appropriate and commonly used in practice. It is relatively straightforward and reflects how the market values similar companies. DCF is also valid but can be more sensitive to long-term growth assumptions. The dividend growth model is less suitable if the company doesn’t pay consistent dividends.

Sensitivity analysis (or ‘what-if’ analysis) is specifically designed to show how changes in one individual variable (like raw material cost) impact the outcome (e.g., NPV). It directly answers the finance director’s question about the project’s vulnerability to that specific factor, unlike scenario analysis (which changes multiple variables together) or Monte Carlo (which models many variables probabilistically).0