Question

Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is Steve using?
Simulation testing.

Scenario analysis.

Rationing analysis.

Sensitivity analysis.

Break-even analysis

Answer 1

Answer:

Scenario analysis

Explanation:

When you are trying to evaluate one or more possible investment projects, then it is always best to try to identify a range of potential different and reasonable outcomes.  

We should start with a scenario that should be the most likely to occur and use its values as a base for comparing different possibilities. This base scenario should give us a positive NPV, if it doesn't there is no need to continue.

Then we can do a more optimistic analysis, for example, what if our sales are 15% higher than expected and / or our costs are 15% lower than expected. This should give us a higher NPV.

Finally we can proceed to do a very pessimistic analysis, where are sales are 15% lower and / or our costs are 15% higher. At what point will the project's NPV become negative.

After we have analyzed these 3, 5 or 7 scenarios (depending on the complexity of the project) we should try to determine how possible are these scenarios.

This type of analysis also gives us a guideline about what to expect especially don't go as planned.