Understanding sensitivity analysis
In Chapter 10, Valuation, we computed a value for equity share price. As a result of the uncertainty inherent in your model, you should take some steps to mitigate this. One way is to run some tests to see how the share price behaves when you change some of the inputs and drivers utilized in arriving at that value. This process is called Sensitivity Analysis. Apart from the volatility of your target value, it also indicates which inputs or drivers have the greatest effect on the target value.
You will need to identify two inputs or drivers that appear to hold prominence in your model:
- Turnover: We have already mentioned that turnover is the most prominent figure on the income statement. So we can use the revenue growth driver as one of the items to sensitize.
- Terminal Value: Another item of prominence is the terminal value.
We have seen in Chapter 10, Valuation, how much of an impact this has on your share price valuation. You...
