Series 79: Step Five: Conducting A Sensitivity Analysis

Step Five: Conducting a Sensitivity Analysis

Since a DCF analysis is in essence based on a series of predictions, educated guesses of a sort, there is much room for variability related to its outcome. Therefore, after establishing an implied valuation for the target company, the final step of a DCF should be to perform a sensitivity analysis. The sensitivity analysis is a manner of adjusting the overall valuation based on slight changes in several of the variables that figured into that outcome, creating a range of potential values in the process. In a sensitivity analysis, key financial data such as WACC, rate of growth, and earnings per share are set at different levels to test how those changes will affect overall projected value of the target company. Also called a “what-if” analysis, the sensitivity analysis is an important means of predicting alternative outcomes given the somewhat speculative n