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Sensitivity analysis is a way of determining the importance of various valuation assumptions. It asks the question: if something changes, how much does the value conclusion change? If it changes a lot, the assumption is “sensitive” and could be argued. If it does not, the assumption is “insensitive” in that it does not make much difference in the end.
We are appraising a business that earns revenues of $100 and EBITDA of $1. We decided that the most appropriate valuation method is to capitalize next year’s earnings at a multiple of 4. In this simple example, the only moving parts are the forecast of next year’s revenue and profit margin. We think that the most probable forecast is sales of $105 and EBITDA of $1.05, based on a 5% growth rate for sales and a constant 1% profit margin. At a multiple of 4, the equity is worth $4.20.
Now let’s do a sensitivity analysis:
That is the story of sensitivity analysis: see how much the value changes relative to changes in key assumptions, determine which ones are the most important, and be able to defend the basis for them.
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About Western Reserve Valuation Services LLC
Western Reserve Valuation Services LLC, based in Columbus, Ohio, is a leading provider of valuation services and financial opinions relating to corporate finance transactions, corporate tax planning and compliance, succession planning and wealth preservation, employee stock ownership plans (“ESOPs”), financial reporting and portfolio / fund valuations. For more information, visit www.wesresvaluation.com or call (614) 448-3700.
Western Reserve Valuation Services is an affiliate of Western Reserve Partners LLC, a FINRA-member investment banking firm offering financial advisory services relating to mergers and acquisitions, capital raising and financial restructuring. For more information on Western Reserve Partners, please www.wesrespartners.com or call (216) 589-0900.