Issues are a part of all projects. Finding out the best solution to these issues is the victory point of a project. Here, we are going to discuss the techniques used to evaluate uncertainty issues faced during capital budgeting of a business.
- The Break-Even Analysis: As an entrepreneur, business person or student, you should definitely know the factors that lead a project to a money making business and also the lacking qualities that can simply risk your money. There also exists a stand-still or neutral point where neither of the money processes occurs. If you are able to identify this specific level, then you can confidently move on with your project.
For example, imagine a project is for $40000 that earns $2 per unit sold out. Now you expect to make a huge profit by selling 27,000 units. This might be a mistake in your decision leading to a loss. But if you know a particular safe zone like selling 7000 units, it would be an appreciated decision. Further, this account for a good starting point and is referred to as the Break-even analysis.
Cons: The result is not specific and it is based on probabilities.
- The Sensitivity Analysis: This is based on the outcome sensitivity of a project or a way to answering our questions about the project.
While accounting for budgeting of a project, we usually get into a bunch of thoughts like how many units will be sold, the completion period of a project and so on.
Here we use this analyzing technique to encounter an assumption leaving all other queries as such. This can be explained with an example.
You are going to buy a washing machine which cost $1000 extra compared to the base model. At the same time, this machine offers you a cost saving in terms of power consumption. Now you really begin to make out the assumptions and calculations about whether you be profited from the purchase or not. At this state, you can use the sensitivity analysis to iterate on cost savings leaving all other parameters to remain.
- The Scenario Analysis: This is an often used method as we are always unsure about more assumptions. We extend the sensitivity analysis to check on a number of varying parameters and are coined as scenario analysis.
Here we expect to meet the best case, the better than expected scenario. For this, we step into extreme decisions.
Even though all these examples of analysis are mind calculations, we use a real-time approach of NPV while capital budgeting.