11.12 - Sensitivity and risk analysis

Introduction

Sensitivity analysis applies to both financial analysis and economic efficiency analysis.

Identification of risks

Risks are different between options with and without private sector financing and/or operation. Technical capacity, financial backing, business acumen, project life and government exposure are very important considerations where there is private sector involvement.

Identification, quantification and assignment of risks among relevant parties are essential for projects involving private sector financing and for road tolling projects. This should include preparation of a risk management plan.

For private sector financing, it is essential to ensure that the commercial arrangement with the private sector is appropriate and that any probity and accountability requirements are met. The degree to which risks can be shared with, or assumed by, private sector participants must be identified. Details of likely contractual obligations as they affect pricing, ongoing risk to government, terms of the contract, termination arrangements and debt and equity contributions of each party should be clearly specified.

Test assumptions

The impact of risks (their probability or likelihood of occurrence and the consequence) on the project results must be tested by sensitivity analysis. Critical assumptions that could be varied should be altered one at a time.

Test affect on cashflows

For financial analysis, analyse the sensitivity to variations associated with cashflows for each option, eg changes to key variables by ±20 percent and different combinations of key variables which taken together represent an alternative, plausible and consistent view of the future.

Calculate and present summary financial measures for the best and worst cases and for specific changes to key variables that are deemed highly probable. Break even points (at which the project begins to lose money) should be identified.