November 26, 2020

Sensitivity Analysis

2 min read

Sensitivity Analysis
Among the most important assumptions made in the computation of the value of the company is the growth rate of cash flows until infinity. When the growth rate of the cash flow changes, it will have a consequence on the final valuation of the company. It is necessary for the company to perform a comprehensive assessment of the growth rate of the cash flows and determine whether it is sustainable. The long-term growth rate of the cash flow has a significant impact on the share valuation in the company. Informed investors usually rely on the cash flow growth projections to determine whether they will invest in the organization. When the cash flow growth rate is positive, the investors feel more confidence to invest in the company as its stock valuation is likely to grow significantly.

When the growth rate infinity of cash flows is changed from 3% to 1%, the firm value reduces to $2,239,486.68 from $2,508,334.88. When the growth rate of cash flow infinity increases to5% from 1%, the value of the company increases significantly to $2,911,607.18. It is clear that the growth rate infinity assumption has a significant impact on the overall value of the firm. When the financial analysts’ makes mistakes in overestimating the growth rate infinity, it means that the firm value will be overvalued making it difficult for the investors to invest in an overvalued company. On the other, when the assumption of growth rate infinity of cash flows is assumed incorrectly at a lower rate, it makes the firm undervalued and the stockholders might make some losses in case the company is acquired. Therefore, the financial analyst of the company should rely on market research and information about the company to estimate the right growth rate infinity of cash flows for projection of the company’s value.

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