Sensitivity analysis is a systematic method for examining how the outcome of benefit-cost analysis changes with variations in inputs, assumptions, or the manner in which the analysis is set up.
See Dealing with Uncertainty for a discussion about using sensitivity analysis for uncertainty in model inputs, such as in examples 1 and 2 above, and for:
The process described in Dealing with Uncertainty can be used when differences of opinion arise regarding values related to variables such as time. In decision-making, it is useful to know whether differences in these values affect project rankings.
Sensitivity analysis can also be used to assess the effects of model assumptions as in example 3.
Consider the assumptions made in setting up the model and how they may affect the benefit-cost measure. These assumptions include:
The type of benefit-cost measure used can also affect the project ranking. Bigger projects will have a higher net present value than smaller projects with the same benefit-cost ratio. In the figure below, "b" has the highest benefit-cost ratio, indicated by the slope of the blue line through the origin and "b" being greater than the slopes for" a" and "c". However, "a" has a higher net present value, indicated by the intercept of a 45-degree line through the point on the vertical axis.
Federal Highway Administration.Status of the Nation's Highways, Bridges, and Transit: 2002 Conditions and Performance Report. Available at: http://www.fhwa.dot.gov/policy/2002cpr/ch10.htm.
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